June 25, 2012
Tobin: The Tax Treatment of Ann Romney's Dressage Horse Activity
Donald Tobin (Ohio State), Ann Romney’s Tax Deductible Horse Activity -- The Tax Code Got This Right!:
Ann Romney’s love of horses and Steven Colbert’s infatuation with Rafalca, one of her dressage horses, have created a buzz about horses, money, and taxes. Romney owns a one-third interest in Rafalca, and Rafalca will be competing, with her rider, Jan Ebeling, in the Olympic dressage event. In the most recent uproar, the Romneys are criticized for deducting $77,731 for the Romney’s share of Rafalca’s expenses. But here is the catch: Because of anti-abuse provisions contained in the Tax Code the Romney’s only actually deducted $49 on their return. Assuming the Romney’s are in the 35% tax bracket, the benefit to the Romneys was about $17. Not much worth working yourself into a lather about.
Although it is not clear what expenses make up the $77,731 figure on the Romney’s return, assuming the figure is correct, the Romney’s effectively received no tax benefit from the activity. They will only recoup these expenses if the Rafalca activity returns a profit. Here is how it works.
Under Section 469 of the Code, losses from passive activities, generally activities where you are a passive investor and do not materially participate in the activity, are only deductible against passive gains. The passive loss provisions were added as part of the Tax Reform Act of 1986 as part of a series of changes to clamp down on abusive tax shelters. The idea was to prohibit taxpayers from deducting losses when the taxpayer was not primarily involved in the activity.
If a person actively runs a business, the activity is not a passive activity and the profit and loss from the business can be deducted on a tax return. So for example, pretend your spouse is a teacher making $50,000 a year and you run a hot dog stand. If the hot dog stand loses money (say $10,000), you can deduct the $10,000 loss from the $50,000 your spouse earned. That is what some news reports were implying when they said the Romney’s deducted $77,731 from the horse activity.
There is a catch however. If there were a passive investor in the hot dog stand who did not participate in its management or operation, and she incurred the $10,000 loss, she could not deduct the loss unless she had other passive gains. The idea is that the Code allows the loss once someone can show that he has some gain in some passive activity. The Romneys are arguably in that situation. Since the $77,731 is a passive loss it can be deducted only against passive gains. Since the Romneys had a lot of passive losses, they had to allocate the passive gains among the various losses. The Romneys generated $2,170 in passive gains, and had over $2 million in losses. The passive gains were thus spread across the losses. Once this allocation was done, $49 of the horse activity was deductible against the $2,170 in income. In effect, the Romneys were not able to deduct over $2 million in passive losses.
Now some have noted that the Romneys may still get the deduction because they can carry over the loss to future years. The Code provides that if an asset is fully sold, the loss generated from the activity, if it is an activity engaged in for profit, would not be a passive loss. Thus the Romneys will only get a large tax deduction from Rafalca, if Rafalca is sold at a loss and they actually suffer a loss. This raises the specter that taxpayers may ultimately be subsidizing Romney’s horse activity.
The Romney story caught my eye because I am constantly telling my wife that we cannot deduct expenses for Patrick, the wonderful, but not Olympic caliber, dressage horse she rides. Why can Ann Romney deduct expenses for Rafalca while we cannot deduct expenses for Patrick? That raises one more question. Is the Romney activity actually an activity for profit, or is it a hobby? Does she actually intend for Rafalca to turn a profit? Would she actually sell Rafalca? I don’t doubt that Rafalca could be sold for a huge amount of money, but could she be sold for a profit? If the activity is a hobby, the Code limits the deduction by only allowing expenses to the extent of gains. Thus, if Romney’s activity is a hobby and not an ordinary and necessary business expense or an investment activity, she could not deduct losses in excess of gain.
The moral of this story, however, is that the Tax Code is working here to properly disallow the deductions. If Ann Romney is engaged in this activity as a hobby and not as a business, her deductions should be limited to her income from the activity. Ann Romney’s love of horses is admirable and her care of Rafalca commendable. Taxpayers should not foot the bill when wealthy individuals, or not so wealthy individuals, engage in these types of activities for love, and not profit. Ann Romney clearly loves horses, and she is sharing that love with others. From my perspective, it is her money, and her love, so go for it. I and glad that at the moment the Tax Code is working and that I, and other taxpayers, are not subsidizing Ann Romney’s horse activity. I already do enough of that at home.
|The Colbert Report||Mon - Thurs 11:30pm / 10:30c|
|Mitt Romney's Blue-Collar Equestrian Pastime|
|The Colbert Report||Mon - Thurs 11:30pm / 10:30c|
|Mitt Romney's Champion Horse & Stephen's Dressage Contribution|
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WTF thinks these tax laws up! GOOD GOD they have convoluted minds.
Posted by: SKIP | Jun 25, 2012 10:08:16 AM
Disagree with the statement that you need passive gain/income to deduct passive losses that are carried over. There is a big difference between passive losses (deferred) and hobby losses (disallowed).
If Rafalca is a distinct passive activity, the Romney's will (with minor exceptions) get a full deduction for all deferred expenses in the year they dispose of their interest in the activity. This would be regardless of whether they otherwise realize any gain on the disposition.
However, if the expenses result in a "hobby loss", there is no carryover and no deduction is allowed for expenses in excess of income - determined on a year by year basis.
Posted by: LJB | Jun 25, 2012 11:55:20 AM
Agree with LJB, if there is a disposition resulting in a gain or a loss, the suspended PALs will be allowed at that time.
If Rafalca is not sold in a 469(g) disposition, then I believe the passive losses also go to horse heaven along with the horse.
One other point - if the Romneys generate net passive income from other activities either through ongoing profit or by a gain on a sale (including unrecaptured 1250 gain) then the suspended losses from this activity will be fully or partially allowed.
IOW, conceivably over time, the entire $78K - plus whatever is added to the cumulative losses as years go on - could become a tax deduction. That is, presuming that the activity is not a hobby loss, as pointed out by LJB.
This reminds me a bit of the Babilonia case where the skater's parents claimed charitable deductions for her training expenses as a contribution to the US Olympic Committee and was denied in Court of Appeals. Should her parents instead have structured that instead as a PAL to be offset by her future winnings and earnings? Should all Olympic hopefuls be structuring their activities ala Rafalca?
Posted by: BLN | Jun 25, 2012 12:34:15 PM
LJB: Thanks for posting. Can you include cites? I tend to agree with the author, but wanted more info on your position. Regards!
Posted by: Baja Bert | Jun 25, 2012 12:47:55 PM
What a shock. There has been such concern over Mrs. Romney's horses, while there was none over the concealed tax avoidance on the income from the fortune of Teresa Heinz (Kerry) or the hobbies of her "reporting for duty" husband, which includes sailing on a yacht that, to this day, there is no report of his having paid the taxes on it after being caught.
Posted by: Woody | Jun 25, 2012 5:28:10 PM
@ Baja -- 26 USC 469(d)(1) defines suspended passive losses in the aggregate. You add up all your losses from passive activities, all your gains from passive activities, and if there's a loss you suspend it. the loss is allowed in the year the investment is disposed of per IRC 469(g). Losses not allowed in one year are carried forward to the next yer per IRC 469(b).
Posted by: jpe | Jun 25, 2012 8:51:45 PM
They are the Romneys.
They are not the Romney's.
Posted by: Barbra Klingonstein | Jul 12, 2012 5:19:52 PM
As you point out the 2010 benefit was just a $49 tax deduction and as you well know we taxpayers choose which losses to claim. It is very telling that Mitt Romney a man that made over $43 million in the past 2 years, a former governor, past potential vice-president candidate, and current presidential candidate could not resist taking a passive loss that resulted in just a $49 deduction.
Even if one imagines the horse is sold for many millions in the near enough future to benefit from the loss carry forward would deducting the full $77,731 make any difference at all to the lifestyle of a man worth over $250 Million
It is very sad that Romney who has been in the public eye for at least a decade and choosing to make himself the subject of even more scrutiny as a presidential candidate could not resist taking such a minute deduction relative to his income and net worth even though he should be smart enough to know the obvious political problems it would generate.
The Romney dressage horse deduction shows that a very, very, very, rich man could not resist trying to get even just a tiny, little bit more by taking a deduction that would let him keep a measly $49 instead of giving the $49 to the country he supposedly wants to unite, improve, and lead as its President.
Clearly the issue is not whether the deduction was legal. The issues are flaws in the tax code, Romney's lack of political awareness, his insensitivity to the common man, his obnoxious greed, his selfishness, and his indeed a lack of patriotism.
The kind of patriotism asked of all Americans, Democrats and Republicans, by President Kennedy when he said "My fellow Americans: ask not what your country can do for you - ask what you can do for your country."
Mitt Romney's choice to claim a dressage horse business loss shows that when faced with a choice he could not spare $49 for his country.
Posted by: PMorgan | Jul 19, 2012 8:12:59 AM
PMorgan engages in a great deal of speculation. He calls forth an image of Mitt sitting in his den, with pencil sharpened, filling out his 2010 tax return...contemplating "Do I take the $49 or not??" Of course Mitt Romney does not prepare his own tax return (he's much smarter than Tim Geitner) and it's unlikely he was even aware that a $49 deduction was included it the return. Even if he had, it's still a legal deduction.
P then goes on to display his ignorance of how taxes work by suggesting Mitt decided to keep the $49 instead of giving it to his country...the deduction may have been $49 but the tax savings was only $17.
Finally P gets to his real point; Paying taxes is patriotic. This is a concept leftist have been floating for a few years but each time they're asked to show their patriotism by sending more of their own money to the government they sputter and yammer.
The voters won't be confused by the distractions floated by the dems.
Posted by: Pilipo | Jul 30, 2012 6:14:12 PM
Yes, as a financial professional, I doubt that Mitt Romney was the den of one of his mansions with a pencil filing out his tax returns. And there is no need to speculate. My point, which intelligent readers surely understood, was that claiming this deduction clearly shows that Romney chooses to direct his tax professionals to take every deduction possible without regard to the political appearances, societal consequences, or even whether the financial benefit is material to his financial well being.
Or are we to believe that Romney is not responsible in anyway for the tax returns he signs and files as truthful and accurate under penalty of law?
And, YES I DO BELIEVE THAT PAYING TAXES IN A REPRESENTATIVE DEMOCRACY IS PATRIOTIC.
Pilipo since you clearly state that you think paying taxes is not a patriotic and instead a "leftist concept," I must ask, Are you even an American Citizen?
During the 1750s and 1760s the primary grievance of the British colonists that led to the American Revolution and the founding of the United States of America was not the existence of taxes or even that the taxes were too high but instead "No taxation without representation."
And to quote, James Madison, U.S. President, "The power of taxing people and their property is essential to the very existence of government."
Somalia and many other lawless states offer tragically clear examples of countries with effectively no taxes and thus no government or real democracy.
The legendary jurist Oliver Wendell Holmes, Jr. perhaps said it best when he said "Taxes are the price we pay for a civilized society."
The manner in which Mitt Romney handles the issue of taxes is in stark contrast to that of another very, wealthy Republican, his father George Romney. George Romney did not stash his millions overseas tax havens. And George Romney was so respectful to the American people and to the forthright, honest, and open leadersip that is essential to a representative democracy that as a candidate for President he made public 12 years of tax returns.
George Romney said..."One year could be a fluke, perhaps done for show, and what mattered in personal finance was how a man conducted himself over the long haul."
Thank You Pilipo for making my point even stronger by pointing out that the 2010 financial benefit to Romney may have been only $17 which even better illustrates the failed cost benefit analysis on Romney's part for the aggressive deduction strategy he clearly told his tax preparers to pursue.
The deduction also indicates a possible failure of his tax advisors who clearly aware of their clients political roles, visibility, and aspirations should have advised their client that just $17 was not worth the negative scrutiny. Or perhaps his tax professionals did in fact advise Romney not to claim the deduction but he told them to do so anyway because he could not spare $17 for America.
Posted by: PMorgan | Jul 31, 2012 8:43:28 AM