The Eight Circuit Court of Appeals informed a West Des Moines taxpayer last week that her "cattery" was a mere hobby, and not a legitimate trade or business. The case involved a corporation whose principal source of income was from information technology consulting. This woman was the only shareholder and employee of the corporation, which operated out of her home. The IRS's issue was that the corporation also operated a cattery to breed, sell, and show kittens that produced very little revenue, but had very high expenses.
In 2003, the cattery had expenses of $60,968 for food, grooming, veterinary bills, and travel to competitions. The cattery produced no revenue that year. With similar expenses in the next two years, the cattery produced $250 in revenue in 2004 from selling three cats, and produced $1,525 in revenue in 2005 from the sale of eight cats. The Eight Circuit agreed with the Tax Court in disallowing the deductions, finding the cattery was a personal hobby and not a genuine trade or business. So what exactly is required to qualify as a trade or business under 26 USC § 162(a)?
The US Supreme Court has stated that for an expense to qualify for as a §162(a) trade or business expense, the primary purpose of the activity must be income or profit. Comm'r v. Groetzinger, 480 U.S. 23, 35 (1987). It is not required that the activity be profitable, or even have a reasonable likelihood of returning a profit, but rather the taxpayer must have a good-faith subjective intent to make a profit or produce income. Id.
In this case, all was not lost, the court noted she had a website marketing these kittens and had raised four national champion kittens. In case you are curious, the corporation dropped the operation in 2006 after breeding prolems, but the individual continued the business as a separate venture.
For a chain of coverage of this story, including coverage of the Tax Court opinion, see the Roth & Company Blog.