Court disallows horse breeding losses but rejects penalties after adviser reliance
Schumacher v. Commissioner, T.C. Memo. No. 4276-23. 2026. Court Opinion
If you run a horse activity with poor records, ongoing losses, and clear personal enjoyment, you may lose business deductions under § 183, even if you spend significant time and have expertise. However, you might still avoid penalties if you can show you relied in good faith on a qualified tax adviser.
Holding
The Tax Court held that Keith and Rhonda Schumacher did not operate Schumacher Quarter Horses for profit under § 183 during 2017, 2018, and 2019. The Court sustained the IRS’s disallowance of their horse-related loss deductions, subject to Rule 155 computations. Still, it held that they were not liable for § 6662(a) accuracy-related penalties because they reasonably relied on their longtime accountant and enrolled agent.
Why It Matters
This is a typical but helpful § 183 case. The court used the standard nine-factor profit-motive test and decided that ongoing losses, weak records, no business plan, and personal enjoyment were more important than the Schumachers’ horse expertise and time spent.
The decision reinforces that equine activities receive a special statutory safe harbor, but taxpayers must actually meet the safe harbor. Horse breeding, training, showing, or racing is presumed profit-motivated only if it produces profits in at least two of seven consecutive years. SQH never made a profit.
The penalty holding matters separately. The taxpayers lost the deduction issue but avoided penalties because they disclosed information to a competent adviser, discussed § 183 compliance annually, and relied on his judgment.
The case distinguishes care and effort from profit motive. The Court accepted that the Schumachers took substantial care of the horses and spent significant time on the activity, but those facts did not establish a business objective.
Key Facts
Keith and Rhonda Schumacher operated Schumacher Quarter Horses, or SQH, as a sole proprietorship beginning in 2001. SQH bred, raised, trained, and showed quarter horses.
Dr. Schumacher was a veterinarian and shareholder in Northeast Nebraska Veterinary Services, PC. During the years at issue, he worked full time, often 60 or more hours per week. Mrs. Schumacher worked full time in education. Their son also helped with horse-related chores.
The Schumachers had extensive personal experience with horses. Dr. Schumacher had owned horses for most of his adult life, completed a 12-week horse training course in 2019, and regularly discussed breeding with AQHA members. Mrs. Schumacher had experience in barrel racing, roping, showing, and training.
SQH achieved competitive success. Schumacher horses placed highly at AQHA World Championship Shows. One mare was a two-time reserve world champion and three-time top ten contender.
The activity did not achieve financial success. SQH had no profitable year from its founding in 2001 through the years leading up to the Court. From 2010 through 2019, it reported annual Schedule F losses ranging from $51,028 to $210,148.
For the years at issue, the Schumachers reported Schedule F losses of:
2017: $161,321
2018: $165,149
2019: $129,908
Those losses offset substantial income from other sources, including wages and passthrough income from Northeast.
The Schumachers maintained a separate SQH bank account, but they frequently paid horse expenses from their personal account. Their personal account also served as overdraft protection for SQH. They tracked income and expenses mainly through bank statements, handwritten notes, and receipts. They did not maintain per-horse expense records.
They had no written business plan. The Court also found no unwritten plan supported by their conduct.
Robert Cruise, an accountant and enrolled agent, prepared their returns for approximately 20 years. He also prepared tax returns and bookkeeping for Northeast. The Schumachers discussed § 183 compliance with him each year. He advised them that SQH qualified as a for-profit activity despite its history of losses.
The IRS examined the Schumachers’ 2017 through 2019 returns and determined deficiencies of $62,266, $61,466, and $67,447. The IRS also asserted § 6662(a) penalties of $11,458, $11,697, and $10,365.
Statutory or Regulatory Framework
Section 183 limits deductions for activities not engaged in for profit. A taxpayer may generally deduct ordinary and necessary business expenses under § 162, but expenses from a hobby or recreational activity are deductible only to the extent allowed by § 183.
For horse activities, § 183(d) provides a favorable presumption. An activity consisting in major part of breeding, training, showing, or racing horses is presumed profit-motivated if gross income exceeds deductions in at least two of the seven consecutive years ending with the taxable year.
SQH did not qualify for that presumption because it had never produced a profit.
The Court therefore applied the nine-factor test under Treas. Reg. § 1.183-2(b). The taxpayer’s profit expectation need not be reasonable, but it must be actual, honest, and held in good faith.
Section 6662(a) imposes a 20% penalty on underpayments attributable to negligence or substantial understatement of income tax. Section 6664(c)(1) removes the penalty when the taxpayer shows reasonable cause and good faith. Reliance on professional advice can establish reasonable cause if the adviser was competent, the taxpayer provided necessary and accurate information, and the taxpayer actually relied in good faith.
Arguments
Taxpayer argued:
SQH was operated with a profit objective.
Their horse knowledge, training experience, and AQHA involvement showed expertise.
They devoted substantial time to the activity despite full-time employment.
Their changes in breeding and training strategy reflected attempts to improve profitability.
They relied on their longtime accountant and enrolled agent for § 183 advice.
Government argued:
SQH lacked a profit motive under § 183.
The Schumachers did not keep complete and accurate books and records.
The separate SQH account functioned as an extension of their personal account.
SQH had no business plan and no meaningful cost-control strategy.
The activity produced uninterrupted losses for at least 18 years.
The taxpayers had substantial income from other sources and used SQH losses to offset that income.
The taxpayers personally and recreationally enjoyed horse activities.
Court’s Reasoning
The Court found that SQH was not operated in a businesslike manner. The Schumachers kept handwritten notes and receipts, but the Court viewed those records as tax-reporting records rather than tools for reducing costs, increasing profit, or evaluating performance.
The Court gave weight to the commingling of personal and business funds. Although SQH had a separate bank account, the taxpayers often paid horse expenses from their personal account and replenished SQH with personal funds.
The absence of a business plan weighed against the taxpayers. A written plan was not mandatory, but the Court found no conduct showing an unwritten financial plan.
The Court rejected the taxpayers’ claim that operational changes showed a profit objective. Their changes in breeding and training produced competitive success but not profitability. The Court found no evidence that they tried to reduce expenses.
The Court credited the taxpayers’ horse expertise. Their experience, AQHA involvement, and Dr. Schumacher’s training course supported them on the expertise factor.
The Court also credited their time and effort. Dr. Schumacher spent two to four hours per day with the horses; Mrs. Schumacher spent substantial time; and the family maintained the activity year-round.
The appreciation factor favored the IRS. The taxpayers did not provide adequate horse inventory records or valuation evidence, so the Court could not determine whether the herd could appreciate enough to offset prior losses.
The history of losses strongly favored the IRS. SQH had operated since 2001 and had never turned a profit. The Court found no credible explanation for the startup period.
The taxpayers’ financial status favored the IRS. They had substantial non-SQH income and could absorb the losses.
Personal pleasure favored the IRS. The Court found that the Schumachers derived substantial enjoyment from breeding, raising, training, racing, and showing horses.
The Court concluded that six factors favored the IRS, two favored the taxpayers, and one was neutral. It held that the Schumachers lacked an actual and honest profit objective.
Penalty Analysis
The IRS met its burden of production for the § 6662(a) penalties. The Court found that the understatements likely exceeded the statutory threshold for substantial understatement, as measured by Rule 155 computations.
The IRS also satisfied § 6751(b)(1). The revenue agent prepared a penalty approval form on October 16, 2020, and her immediate supervisor approved it that same day. The penalties were first formally communicated to the Schumachers on January 5, 2021.
The taxpayers still avoided penalties. The Court found reasonable cause and good faith because:
The taxpayers had little tax-law expertise.
Mr. Cruise was an experienced accountant and enrolled agent.
He had prepared their returns for about 20 years.
He also handled bookkeeping and returns for Dr. Schumacher’s veterinary practice.
The taxpayers discussed § 183 with him each year.
Mr. Cruise advised that SQH satisfied § 183.
Dr. Schumacher responded to information requests.
The record did not show that the taxpayers withheld information.
The result is irritatingly human but legally clean: the taxpayers were wrong, but not careless enough to be penalized.
Result
Decision will be entered under Rule 155 disallowing the SQH loss deductions but rejecting the § 6662(a) accuracy-related penalties.
The Takeaway
Horse, farming, ranching, and similar activities need business records that track profitability, not just records for tax returns. Practitioners should see the penalty outcome as a separate lesson: even if § 183 is a risk, getting yearly written advice from a qualified adviser can help support a reasonable-cause defense.
List of Citations
IRC § 183: Limits deductions for activities not engaged in for profit.
IRC § 183(d): Provides the horse-activity presumption requiring profits in two of seven consecutive years.
IRC § 162: Allows deductions for ordinary and necessary business expenses.
IRC § 212: Allows deductions for expenses incurred for production or collection of income.
Treas. Reg. § 1.183-2(b): Provides the nine-factor profit-motive framework.
IRC § 6662(a): Imposes a 20% accuracy-related penalty.
IRC § 6662(d): Defines substantial understatement of income tax.
IRC § 6664(c)(1): Provides the reasonable-cause and good-faith exception to penalties.
IRC § 6751(b)(1): Requires written supervisory approval of penalties before assessment.
Neonatology Associates, P.A. v. Commissioner, 115 T.C. 43 (2000), aff’d, 299 F.3d 221 (3d Cir. 2002): Sets the professional-reliance standard for reasonable cause.
Graev v. Commissioner, 149 T.C. 485 (2017): Addresses the IRS burden to show supervisory approval of penalties.
Engdahl v. Commissioner, 72 T.C. 659 (1979): Explains profit motive and startup losses in horse-related activities.
Dunn v. Commissioner, 70 T.C. 715 (1978), aff’d, 615 F.2d 578 (2d Cir. 1980): Confirms that no single § 183 factor controls.