University of Vermont AAHS

Gallo v. Oregon Department of Revenue


Oregon Tax Court

UNPUBLISHED, 2003 WL 21675927

July 8, 2003


Summary of Opinion


Plaintiff Gallo, a medical doctor, deducted substantial sums from her Oregon income taxes for loses from her horse breeding and showing operation.  The Oregon department of revenue claimed she did not have an intent to make a profit and disallowed the deductions.  In this opinion, the Oregon Tax Court upholds that decision using the same guidelines used by federal courts for federal income taxes.


Text of Opinion





 Plaintiff Catherine J. Gallo is a medical doctor specializing in neurosurgery in Eugene. Plaintiff is married, mother of three children, and stepmother of two children. She came to Oregon in 1987 to establish her medical practice after experiencing resistance to her attempts to do so in the south where she grew up. Plaintiff also experienced resistance in Oregon which she overcame with determination, skill, and hard work. Over the years she developed a thriving practice first in Springfield and later in Eugene.


 Plaintiff testified that neurosurgery is a highly stressful specialty that many practitioners retire from between the ages of 50 to 55. Consequently, in the early 1990s she decided to find alternate means to support herself to enable retirement from medicine in 5 to 10 years. Plaintiff testified that she began educating herself about the process of buying and selling stocks as one way to make money.


 Plaintiff eventually came into contact with Saddlebred horses about 1994, which she thought were beautiful animals. Plaintiff had done some riding as a girl growing up in Louisiana but was not involved in training or breeding. In 1994 she began her horse venture in the hope of one day supporting herself on horse business income.


 Plaintiff's first entre into the horse venture was purchasing a horse on the advice of teenager Dana Waddell, her riding instructor. From 1995 to 1999 she bought several horses on the advice of Waddell who served as both her riding instructor and horse trainer. Among those were Coloration (Sunya), Tycoon, CH Flourish (Charlie), Corporate Primadonna (Camilla) and Desert's Classy Memories (DCM). Plaintiff testified that she was told by Waddell that the horses could be "flipped," meaning that they could be trained and then sold in a year or so for substantial sums. Plaintiff also bought a foal monitor and a horse van on Waddell's advice. Plaintiff testified that her plan was to generate income from renting the van and monitor. Plaintiff also bought an RV that she hoped would save money on hotel fees while attending horse shows.


 To educate herself about the business of buying, selling, and breeding horses, Plaintiff read books and magazines about breeding, bloodlines, and showing and also watched videotapes. She also obtained the advice of trainers, breeders, and owners who had been successful.


 In 1999 Plaintiff came to the conclusion that Waddell was unable to give her the training and selling results she wanted. She then fired Waddell and moved her horses to the 100‑acre Springfield farm of Timothy Arcuri. Arcuri has had a successful business training, breeding, showing, and selling horses for over 30 years. He testified that he currently has about 25 clients, most of whom are hobbyists.


 After moving her horses to Arcuri's farm, Plaintiff made a number of substantial changes to her horse activity. On Arcuri's advice, she sold both the foal monitor and horse van because he determined neither was going to be profitable. She sold or donated several horses Arcuri considered lower market. One horse was sold at auction, one was donated to 4‑H and another was donated to a college in the Midwest. Also on Arcuri's advice, Plaintiff purchased Matrix and Presley in 2001.


 Since 1998, Plaintiff has changed her horse activity including changing to an accountant who specializes in horse businesses, obtaining separate bank accounts and credit cards, and using software to track expenses on a per horse basis.


 Plaintiff has encountered several obstacles in her horse venture. She suffers from an acute case of performance anxiety while showing horses. She testified that American Saddlebreds must be shown by amateurs, preferably the owners themselves. As success in the show ring is the best way to sell horses, she feels she must show the horses herself though she does not enjoy it. She has undergone counseling and takes prescription medicine to counteract her anxiety in the ring.


 The bungled breeding of Plaintiff's valuable mare also affected her ability to make a profit. Plaintiff bred DCM followed by a sophisticated procedure called an embryo washout. In this procedure a skilled veterinarian washes out the embryo of a valuable mare and implants it into a surrogate. The veterinarian then gives the valuable mare a Progestin injection to induce miscarriage in the event of a failed washout. The valuable mare can then continue her show career while still providing her owner with offspring. In DCM's case, the veterinarian incorrectly told Plaintiff that DCM had not conceived, and he failed to perform the Progestin injection. DCM was subsequently sent to Kentucky for costly, intense training by Mitchell Clark. Eleven months later the failure was discovered when the trainer found a foal in DCM's stall one morning. Consequently, the training she had received was wasted; DCM was put out to pasture to raise her foal until it could be weaned. According to Plaintiff, in the horse show world, these events put her too far behind her age group to catch up.


 Of the three horses she now owns, Plaintiff rides Presley in shows and has never ridden DCM or Matrix. She testified that if Matrix wins the world championship, he could sell for $250,000. She also testified that if Presley wins the western world championships, for which he has qualified, he could sell for $100,000. From 1994 to the date of trial Plaintiff purchased 12 horses and sold 9. None of her horses were sold for more than their purchase price and most sold for substantially less or for nothing.


 To date, Plaintiff has never made a profit in her horse activity. As demonstrated below, [FN1] she has in fact suffered substantially increasing losses nearly every year.


FN1. There is a discrepancy between the amounts supplied by Plaintiff for medical practice income for years 1996, 1997, and 1999. Plaintiff's medical practice income for those years according to her federal tax returns are $350,416 for 1996, $423,051 for 1997, and $672,487 for 1999. Plaintiff did not submit her 2001 federal return so that number could not be verified. These discrepancies do not affect the outcome in this case.


[Table of income and expenses could not be reproduced.]





 The issue before the court is whether Plaintiff's horse venture was an activity primarily engaged in for profit. Defendant determined that it was not, disallowed Plaintiff's $55,125 schedule F farm loss and issued a deficiency for tax year 1997 in the amount of $4,945. (Ptf's Trial Mem in Reply at 1.) Plaintiff disagrees. As Plaintiff, she bears the burden of proof. ORS 305.427.


 The Oregon income tax system is linked to the federal income tax system.  ORS 316.007. That statute incorporated by reference the Internal Revenue Code (IRC) and accompanying Treasury Regulations. Hintz v. DOR, 13 OTR 462, 465 (1996). Consequently, federal case law interpreting the IRC is instructive for determining Oregon treatment of income.


 A. IRC section 183


 IRC section 183 provides that when an activity is not engaged in for profit, deductions for expenses of that activity are allowed only to the extent of profit generated. The statute further provides that an activity is presumed to be for profit for tax purposes if it is profitable in three out of five years. IRC 183(d). A more generous rule applies with respect to activities that consist of breeding, training, showing, or racing horses. For those activities the presumption arises if there is profit in two out of seven years. Id.


 From 1995 to 1997, the year at issue, Plaintiff had not had a profitable year. Trial testimony and exhibits contained information for Plaintiff's horse activity up until 2002 at which point she had yet to be profitable. Consequently, the presumption does not apply. Further guidance on the central issue comes from the regulations. Treasury Regulation section 1.183‑ 2(a) (1972) states "[f]or purposes of section 183 and the regulations thereunder, the term 'activity not engaged in for profit' means any activity other than one with respect to which deductions are allowable for the taxable year under section 162 * * * for expenses of carrying on activities which constitute a trade or business of the taxpayer * * *[.]" In order to determine whether an activity is engaged in for profit, the court takes into account objective standards in the context of all facts and circumstances of the particular case. Id.


 Nine factors laid out in the regulations are particularly pertinent:


"1) Manner in which the taxpayer carries on the activity. * * *

"(2) The expertise of the taxpayer or his advisors. * * *

"3) The time and effort expended by the taxpayer in carrying on the activity. * * *

"4) Expectation that assets used in 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, which are earned. * * *

"8) The financial status of the taxpayer. * * *

"9) Elements of personal pleasure or recreation. * * * "


Treas Reg 1.183‑2(b) (1972).


 B. Nine relevant factors


 The court takes into account all facts and circumstances to determine whether a primary profit motive existed. Based on the facts in each case, certain factors will naturally be more weighty. In Golanty v. Commissioner, 72 TC 411, 426 (1979), the Tax Court made the following practical observation, "[a]lthough no one factor is determinative of the taxpayer's intention to make a profit (sec.1.183‑2(b), Income Tax Regs.), a record of substantial losses over many years and the unlikelihood of achieving a profitable operation are important factors bearing on the taxpayer's true intention." Golanty, 72 TC 411, 426 (1979), aff'd without published op 647 F.2d 170 (9th Cir.1981).


 1. Manner in which the taxpayer carries on the activity.


 Plaintiff has a successful medical practice. She understands the requirements of running a profitable business such as keeping proper records, tracking expenses, and collecting accounts receivable. As of 1997 she had not transferred those principles to her horse activity. Plaintiff did not have separate checking accounts or credit cards for the horse activity until 1997. She made no efforts to cut expenses and in fact incurred higher ongoing expenses by purchasing the foal monitor, Mack Tractor, horse trailer and Bounder RV. There is no indication that Plaintiff performed an analysis of any profits that could be derived from these purchases after taking into account the significant expenses they created.


 After the veterinarian failed to properly perform the Progestin injection causing Plaintiff clear financial harm, she took no action to make herself whole. She did not sue him for malpractice, did not have the fees for the procedure returned or negotiate any kind of financial settlement. (Def's Ex A at 62.) Although Plaintiff is understandably loathe to sue a fellow medical practitioner as she stated at her deposition, she should have taken some steps to ameliorate the harm done. It is more likely that a hobbyist would cut her losses than take the uncomfortable but sound business choice of trying to recoup her losses.


 Plaintiff testified that she prepared a business plan in late 1997 or 1998.  (Ptf's Ex 7.) However in a letter she wrote during her audit, she stated, "[i]n 1998 I prepared a rough draft of a business plan based on several estimates of sales prices for Desert's Classy Memories." (Def's Ex B at 3/32.) The audit was conducted closer in time to the creation of the rough draft business plan. Plaintiff's statement at that time is probably more reliable than her present recollection; therefore, the court finds the plan was written in 1998. The rough draft business plan consists of a bell curve of projected horse sales, projected income/expenses and profit from 2003‑2008 based on projected sales, projected profits based on hoped‑for sales of horses she owned at the time, comparison of these hoped‑for sales and profits to the Standard & Poor's Index fund and projected quit dates from her medical practice. (Ptf's Ex 7 .) Although indicative that Plaintiff could calculate the effect of selling horses at high prices and thereby receiving profits, they do not show how Plaintiff was taking action to affect making profits.


 Calculating hoped‑for outcomes based on events that appear unlikely to occur given Plaintiff's track record is not a business plan. That rough draft business plan mentioned none of Plaintiff's other horses, how she would increase income or decrease expenses, or how her hard assets would contribute to profitability. Plaintiff's situation is similar to the plaintiffs in Prieto v. Commissioner, 82 TCM (CCH) 716 (2001), where the court stated: "Even though they had records reporting substantial losses, petitioners never developed a written business plan or made a budget. Dr. and Mrs. Prieto testified that the 'business plan' of the horse activity was to buy, train (develop), show, and sell horses. This is not a plan; this is merely a statement of what the horse activity did." Prieto, 82 TCM (CCH) 716 (2001), aff'd in unpublished op, ‑Fed.Appx.‑, 91 AFTR2d 2003‑1423, 2003 WL 1508328 (March 24, 2003). The court finds this factor weighs for Defendant.


 2. The expertise of the taxpayer or his advisors.


 Plaintiff began her horse activity with no experience in breeding, training or selling horses. She entered the activity on the advice of Waddell, who was "in her late teenage years." (Ptf's Post‑Trial Mem in Reply at 10.) Waddell claimed she sold a horse for $125,000, however, Plaintiff did not check Waddell's references or otherwise inquire into Waddell's expertise. Plaintiff continued with Waddell for several years, making substantial purchases based on Waddell's advice. In 1997 those purchases included $70,000 for DCM, $25,608 for the Mack Tractor, and $12,000 for the horse trailer. (Ptf's Ex 3 at 18.) Despite skyrocketing expenses and continued lack of success, Plaintiff stayed with Waddell for roughly five years, apparently giving Waddell one of her horses that Waddell had trained poorly. (Gallo testimony.)


 In 1999 Plaintiff switched to trainer Timothy Arcuri who she testified has a successful horse training business. There was no testimony supporting Arcuri's success nor where his profits are derived. He did testify that his roughly 25 clients are generally hobbyists. While Arcuri himself may be able to derive a profit from conducting the affairs of hobby horse owners, that does not indicate he could make Plaintiff's activity as an owner profitable and indeed in the intervening years, Plaintiff has still not made a profit. On Arcuri's advice, Plaintiff did sell several items which generated large expenses such as the Mack Tractor, horse trailer and foal monitor. She also sold or donated several horses that Arcuri felt would not further her activity. She also purchased two horses on his advice that appear to have bright prospects and focused her attentions on fewer horse shows that Arcuri recommended as better grounds for potential buyers. This factor weighs slightly for Defendant.


 3. The time and effort expended by the taxpayer in carrying on the activity.


 Plaintiff testified that she spends approximately 20 hours per week on her horse activity. Although clearly an active, energetic person, the court finds that combining the heavy demands of her medical practice, stock trading, raising three young children of her own and two stepchildren simply would not allow that type of time commitment. Although attending shows might take large chunks of time on an irregular basis, that does not account for 20 hours per week.


 Case law on this factor has looked at whether taxpayers did the day‑to‑ day work of the activity such as feeding, grooming, and mucking out stalls. Engdahl v. Commissioner, 72 TC 659, 662 (1979) (finding an orthodontist and his wife who spent 35‑55 hours per week feeding, grooming, exercising, breeding and mucking out stalls in their American Saddlebred breeding business to be engaged in activity for profit). Such actions indicate both that taxpayers are reducing expenses by employing sweat‑equity, as well as partaking in the dirtier and less pleasant aspects of a horse operation. See Regalado T. Mary v. Commissioner, TC Memo 1989‑118 (1989) (anesthesiologist who spent 50 to 70 hours a week personally caring for horses, cleaning stalls, training and racing them, to the point it created dissension at home, found to be engaged in activity for profit); Morley v. Commissioner 76 TCM (CCH) 363 (1998) (taxpayer conducted horse breeding activity on farm he purchased close to his residence where he personally cared for the horses daily and delivered foals himself found to be engaged in activity for profit). This factor weighs for the Defendant.


 4. Expectation that assets used in activity may appreciate in value.


 Plaintiff did not buy real property for her operation. She did purchase hard assets collateral to her horses such as the Mack Truck, foal monitor, Bounder RV, and horse trailer. Plaintiff did not testify that she expected any of these items to appreciate in value and they did not.


 Plaintiff hoped her horses could be trained and sold for profit. She invested significant funds in training, showing, and breeding her horses. She purchased higher quality horses in hopes that they would be saleable for higher prices. This factor weighs for Plaintiff.


 5. The success of the taxpayer in carrying on other similar or dissimilar activities.


 Plaintiff built a successful medical practice from the ground up while faced with hostility from other neurosurgeons in Lane County. Plaintiff testified that she also trades stocks on a short term basis to generate income. She said she studied this activity and that overall she has reached a return rate of 17 percent. The evidence presented does not support Plaintiff's testimony on this issue. Indeed, it clearly shows the short term trading resulted in losses. This factor is neutral.


 6. The taxpayer's history of income or losses with respect to the activity.


 Plaintiff has never had a profit from her horse activity. She has never sold a horse for more than she paid for it and in fact has sold most for significantly less or even given them away for free. Plaintiff has reported some gross receipts from her horse activity over the years, $545 in 1996, $4,545 in 1997, $721 in 1998, $3,807 in 1999, $29,260 in 2000, and $50 in 2001. (Ptf's Post‑ Trial Mem in Reply at 16.) It is unclear what is included in these receipts, however since Plaintiff testified she sold hard assets on Arcuri's advice, it appears the bulk of her receipts come from those sales, not from horse sales. The court recognizes that the startup phase of a horse breeding activity can be 5 to 10 years. Engdahl, 72 TC at 669. However, in the face of the huge losses she has incurred, $527,176 to date, compared to $38,928 in gross receipts, the court does not see how Plaintiff could ever make enough profit to recoup her losses and become profitable overall. This factor weighs against Plaintiff.


 7. The amount of occasional profits, if any, which are earned.


 Plaintiff has never had a profitable year. She has never sold a horse for more than it cost. Although Plaintiff has hopes of someday selling a horse at a large profit, to date she has not done so. This factor weighs for Defendant.


 8. The financial status of the taxpayer.


 Plaintiff is a successful, highly paid neurosurgeon. She has earned $3,328,935 from her medical practice during the years of the horse activity. (Ptf's Post‑ Trial Mem in Reply at 16.) Although another additional source of significant income does not create a presumption of a lack of profit motive, it is an important factor. Plaintiff states "[t]he argument that a taxpayer would spend $1 with the objective of saving a portion of that $1 in taxes is unconvincing as a matter of human psychology because, so long as the income tax rates are less than 100 percent, there is no benefit in losing money." (Ptf's Post‑Trial Mem in Reply at 5.) This argument lacks merit for two reasons. First, there is incentive for a hobbyist to spend their hobby dollars in pre‑tax dollars. For example, in 1997 for a taxpayer with the highest incremental rates, this allows 48.6 percent more to be spent with the same end result in after tax dollars. See Golanty, 72 TC at 429 (calculating that the plaintiff's losses were smaller than they appeared after taking into account the reduced tax burden the losses produced). Second, Plaintiff took significant depreciation deductions. Depreciation is not an out‑of‑pocket expense and therefore it serves to reduce the level of income from Plaintiff's medical practice without a commensurate outlay of expense. This factor weighs for Defendant.


 9. Elements of personal pleasure or recreation.


 Plaintiff testified that showing horses makes her extremely agitated to the point that she takes medications, has sought counseling, and often feels physically ill while showing the horses. The court accepts that showing horses and success in the show ring are important to selling horses for profit. Engdahl, 72 TC 669. Additionally, it is not required that a taxpayer derive no enjoyment from an activity for a profit motive to be found. This factor weighs for Plaintiff.




 In order for Plaintiff's horse activity expenses to be deductible, she must be engaged in the activity for profit. Under all the facts and circumstances laid out above, the evidence does not support a finding that Plaintiff was engaged in the activity for profit. Now, therefore,


 IT IS THE DECISION OF THIS COURT that Plaintiff's appeal is denied.

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