Could a full-time state employee deduct cattle-operation losses when six federal profit-motive factors weighed against the ranch?

Plain-English summary

David Gonzales could not deduct his cattle-operation losses because six of the nine federal profit-motive factors weighed against treating the activity as a for-profit business. The AHO upheld $5,119 tax and $355.97 interest, but abated the $1,000.36 penalty because an enrolled agent advised him to claim the deductions.

Gonzales had worked full time for the New Mexico Department of Transportation since about 1992. He began a cattle operation in 2001 by leasing cows to roping and rodeo operators, then changed to a breeding and beef operation after deciding the first model was unsustainable.

His herd peaked at about 110 head in 2010. Drought and increased pasture, feed, cattle, and fuel costs caused him to sell most of it in 2011 and 2012. During the assessed 2011-2014 years, he claimed substantial cattle losses and had never made more than what he characterized as breaking even.

Six factors weighed against a profit motive

New Mexico taxable income began with federal adjusted gross income. Section 162 permitted business expenses, but Section 183 limited losses from an activity not engaged in for profit. The AHO applied the nine federal factors:

1. Businesslike manner—against. Gonzales had a separate bank account but no formal plan and did not produce the operation records requested by the Department.
2. Expertise—against. He had family experience, cattle-owner association membership, lectures, seminars, and conversations with ranchers, but the evidence showed casual interaction rather than focused expert consultation to improve profitability.
3. Time and effort—in favor. He spent about 20 hours per week on the cattle, including work in extreme heat and blizzards.
4. Asset appreciation—in favor. The cattle could appreciate depending on market conditions.
5. Success in other activities—against. He showed no successful similar or different business, and his earlier roping-cattle operation was unprofitable.
6. History of income or loss—neutral. Losses were substantial, but severe drought was beyond his control.
7. Amount of profit—against. Occasional small gains were outweighed by large losses.
8. Financial status—against. His DOT job funded his living expenses and cattle operation.
9. Personal pleasure—against. He described the cattle as stress relief and intended to continue regardless of profitability.

The operation therefore failed the profit-motive test, and the Department properly disallowed the losses.

Enrolled-agent advice removed the penalty

Gonzales's representative was an enrolled agent who prepared his returns and advised him to claim the cattle deductions. Considering all the circumstances, the AHO found Gonzales non-negligent and abated the penalty under Regulation 3.1.11.11 NMAC.

Interest remained mandatory because the underlying tax was not paid when due.

Result: protest DENIED IN PART AND GRANTED IN PART. Tax and interest remained; penalty was abated.

What this means for you

Ranchers with recurring losses

Hard physical work and genuine ranching knowledge do not alone establish a profit motive. Keep a written plan, detailed operating records, marketing strategy, expert recommendations, and evidence of changes aimed at profitability.

Taxpayers with drought or other external losses

Uncontrollable conditions can make the loss-history factor neutral, but other evidence must still show that the activity is run as a business.

Accountants and enrolled agents

Document the advice supporting a return position. Professional reliance may remove negligence penalty even when the deduction itself is later disallowed, but it does not remove mandatory interest.

Common questions

Q: Did the AHO find that Gonzales put too little time into the cattle?
A: No. His roughly 20 hours per week and difficult working conditions were a factor in his favor.

Q: Did drought count against him?
A: No. Because drought was beyond his control, the history-of-loss factor was neutral.

Q: Why did the businesslike-manner factor weigh against him?
A: He had no formal plan and did not produce the herd, equipment, improvement, profit, and loss records he said he maintained.

Q: Why was the penalty abated?
A: Gonzales followed the advice of the enrolled agent who prepared his returns, and the AHO found him non-negligent.

Q: What amounts remained?
A: $5,119 tax and $355.97 interest. The $1,000.36 penalty was abated.

Citations and references

Statutes and regulations:

• NMSA 1978, §§ 7-2-2 and 7-2-3 — adjusted gross income and personal income tax
• 26 U.S.C. §§ 162 and 183 — business expenses and activities not engaged in for profit
• 26 C.F.R. § 1.183-2 — nine-factor profit-motive test
• NMSA 1978, §§ 7-1-3 and 7-1-17 — tax definition and assessment presumption
• NMSA 1978, §§ 7-1-67 and 7-1-69 — interest and negligence penalty
• Regulation 3.1.11.11 NMAC — professional-reliance indicator of non-negligence

Cases cited:

• Holt v. New Mexico Department of Taxation and Revenue, 2002-NMSC-034 — Department authority to recalculate taxable income
• Public Services Co. v. New Mexico Taxation and Revenue Department, 2007-NMCA-050 — taxpayer's burden to prove a deduction
• Security Escrow Corp. v. State Taxation and Revenue Department, 1988-NMCA-068 — strict proof of a deduction
• Marbob Energy Corp. v. New Mexico Oil Conservation Commission, 2009-NMSC-013 — mandatory meaning of “shall”

Source

• Listing: New Mexico Decisions & Orders
• Decision post: David M. Gonzales
• Decision PDF: D&O 16-43

Original ruling text

STATE OF NEW MEXICO
ADMINISTRATIVE HEARINGS OFFICE
TAX ADMINISTRATION ACT

IN THE MATTER OF THE PROTEST OF
DAVID M. GONZALES, No. 16-43
TO ASSESSMENT ISSUED UNDER
LETTER ID NO. L0832592944

DECISION AND ORDER

A formal hearing on the above-referenced protest was held on July 29, 2016 before

Hearing Officer Dee Dee Hoxie. The Taxation and Revenue Department (Department) was

represented by Mr. Marek Grabowski, Staff Attorney. Ms. Milagros Bernardo, Auditor, and Ms.

Diana Martwick, Staff Attorney, also appeared on behalf of the Department. Mr. David

Gonzales (Taxpayer) appeared for the hearing with his representative, Mr. Douglas Mote,

Enrolled Agent. Ms. Jessica Elebario also appeared with the Taxpayer. The Hearing Officer

took notice of all documents in the administrative file. Based on the evidence and arguments

presented, IT IS DECIDED AND ORDERED AS FOLLOWS:

FINDINGS OF FACT

1. On November 16, 2015, the Department assessed the Taxpayer for personal income tax,

penalty, and interest for the tax periods from January 1, 2011 through December 31,

2014. The assessment was for $5,119.00 tax, $1,000.36 penalty, and $355.97 interest.

2015. On January 14, 2016, the Taxpayer filed a formal protest letter.

2016. On March 1, 2016, the Department filed a Request for Hearing asking that the Taxpayer’s

protest be scheduled for a formal administrative hearing.

4. On March 7, 2016, the Hearings Office issued a notice of telephonic scheduling hearing.
5. The telephonic scheduling hearing was conducted on March 25, 2016. The hearing was

held within ninety days of the protest.

6. On March 28, 2016, the scheduling order and notice of hearing was issued.

7. On July 14, 2016, the parties filed their joint prehearing statement.

8. The Taxpayer is a full-time employee for the Department of Transportation (DOT), and

has been since approximately 1992.

9. The Taxpayer began a cattle operation sometime in 2001. The initial operation consisted

of purchasing some cows and leasing them out to roping and rodeo operators.

10. The Taxpayer determined that this operation was not sustainable. The Taxpayer found

that his lessors were subleasing his cattle, moving them to other locations, and were not

taking appropriate care of his cattle. Given the time and expense to recover his cattle and

to restore them to health, the Taxpayer felt that he would never make a profit at this

business.

11. Sometime in 2005, the Taxpayer decided to change his operation to a calving operation.

This essentially involves breeding cattle and selling them for beef. The Taxpayer

proceeded to buy what he considered to be a good bull and began breeding.

12. The Taxpayer determined that the type of spotted cattle that he had were not desirable for

beef cattle and directed his breeding efforts toward cattle that would not be spotted.

13. The Taxpayer determined that it might take up to 10 years to breed the type of cattle he

wanted and to grow the herd to a sufficient number of cows to be profitable.

14. The Taxpayer determined that he would need 15 to 20 heifers to be operational and 150

heifers to be able to make a profit. The Taxpayer set a goal of having a herd with 150

heifers by the time he retires from DOT.

David Gonzales
Letter ID No. L0832592944
page 2 of 11

15. At the peak of his operations, in approximately 2010, the Taxpayer had 110 head of

cattle.

16. In 2011, the drought conditions began to significantly affect the cost of pasture land,

feed, cattle, and fuel. In 2011 and 2012, the Taxpayer sold off most of his herd because

of the increased cost of keeping them.

17. Sometime in 2012 or 2013, the Taxpayer’s herd was as low as 18 head. The herd is

currently around 35 head.

18. Even during the peak of his operation, the Taxpayer never made a profit in his cattle

operation. The Taxpayer categorized his best years as “breaking even”.

19. During all of the tax years in question in this protest, the Taxpayer claimed significant

losses on his personal income taxes in relation to his cattle operation.

20. The Taxpayer leases pasture to keep his cattle on and for them to graze. The Taxpayer

also buys supplemental feed and distributes it to his herd as he deems necessary.

21. The Taxpayer apparently makes improvements to the leased land and is responsible for

the maintenance of pens.

22. The Taxpayer spends around 20 hours a week managing his cattle operation. The

Taxpayer often has to take feed or perform other tasks for the cattle in extreme

conditions, such as 100 degree heat or during a blizzard.

23. The Taxpayer belongs to a cattle owner’s association and attends lectures and seminars

about cattle breeding.

24. The Taxpayer’s family was in ranching and cattle. The Taxpayer regularly speaks to

family and friends about his cattle operation.

David Gonzales
Letter ID No. L0832592944
page 3 of 11

25. The Taxpayer tries to keep track of cattle market prices so that he and his friends can

make the best money when they sell their cattle.

26. The Taxpayer maintained a separate bank account for cattle operation. The Taxpayer

said he kept records on his herd, equipment, improvements, profits, and losses, but failed

to produce any copies of such records despite the Department’s repeated requests.

27. The Taxpayer did not have a written or formal business plan. The Taxpayer was acting

based on his personal knowledge and experience.

28. The only efforts articulated by the Taxpayer to make the cattle operation profitable were

to get good bulls, to breed calves that were not spotted, and to try to grow the herd.

29. The Taxpayer indicated that all proceeds realized from sales went back into the operation

for land improvements and such, but these things seemed to be necessary for the

maintenance of the herd and were not geared toward profitability.

30. The only effort articulated by the Taxpayer to reduce the expenses of the cattle operation

was to sell off cattle when the price of feed, pasture, and fuel went too high.

31. The Taxpayer sells his cattle at auction in nearby sale barns. The Taxpayer does not

advertise or try to increase his customer base in any way.

32. The Taxpayer relies on word-of-mouth and luck-of-the-draw for buyers at the auctions.

The Taxpayer admitted that he has had problems with sales and profits when he took

cows to auction and there were few buyers.

33. The Taxpayer derives significant pleasure and personal satisfaction from his cattle

operation. The Taxpayer feels that the cattle operation is a way to relieve the stress of his

job with DOT.

David Gonzales
Letter ID No. L0832592944
page 4 of 11

34. The Taxpayer intends to continue the cattle operation regardless of its profitability, but

the Taxpayer hopes to one day turn a profit.

DISCUSSION

The issue to be decided is whether the Taxpayer is liable for the assessment. The parties

agree that the determination hinges on whether the Taxpayer’s cattle operation should be

considered as a for-profit business or not under 26 USCS § 183. The Taxpayer argues that the

time and effort required to engage in the cattle business make it a for-profit activity. The

Taxpayer argues that getting up so early and going out even in adverse weather only make sense

if the activity is for-profit. The Department argues that the Taxpayer’s conduct was not

sufficient to show that the activity was for-profit. The Department argues that the Taxpayer’s

primary purpose in engaging the cattle business is to relieve the stress of his job with DOT,

family tradition, and for personal enjoyment.

Burden of Proof.

Assessments by the Department are presumed to be correct. See NMSA 1978, § 7-1-17.

Tax includes, by definition, the amount of tax principal imposed and, unless the context

otherwise requires, “the amount of any interest or civil penalty relating thereto.” NMSA 1978, §

7-1-3. See also El Centro Villa Nursing Ctr. v. Taxation and Revenue Department, 1989-NMCA-

070, 108 N.M. 795. Therefore, the assessment issued to the Taxpayer is presumed to be correct,

and it is the Taxpayer’s burden to present evidence and legal argument to show that he is entitled

to an abatement.

The burden is on the taxpayer to prove that he is entitled to an exemption or deduction.

See Public Services Co. v. N.M. Taxation and Revenue Dep’t., 2007-NMCA-050, ¶ 32, 141 N.M.

520. See also Till v. Jones, 1972-NMCA-046, 83 N.M. 743. “Where an exemption or deduction

David Gonzales
Letter ID No. L0832592944
page 5 of 11
from tax is claimed, the statute must be construed strictly in favor of the taxing authority, the

right to the exemption or deduction must be clearly and unambiguously expressed in the statute,

and the right must be clearly established by the taxpayer.” Sec. Escrow Corp. v. State Taxation

and Revenue Dep’t., 1988-NMCA-068, ¶ 8, 107 N.M. 540. See also Wing Pawn Shop v.

Taxation and Revenue Dep’t., 1991-NMCA-024, ¶ 16, 111 N.M. 735. See also Chavez v.

Commissioner of Revenue, 1970-NMCA-116, ¶ 7, 82 N.M. 97.

Personal income tax.

New Mexico imposes a personal income tax upon the net income of every resident. See

NMSA 1978, § 7-2-3 (1981). New Mexico’s adjusted gross income is based on the person’s

federal adjusted gross income. See NMSA 1978, § 7-2-2 (2014). However, the Department has

the authority to examine and recalculate a person’s taxable income. See Holt v. N.M. Dep’t. of

Taxation and Revenue, 2002-NMSC-034, ¶ 23, 133 N.M. 11.

The parties agree that the Taxpayer’s taxable income with respect to the amount of the

assessment hinges upon whether the Taxpayer is allowed to deduct his losses from the operation

of his cattle business. There is a federal deduction for expenses incurred while engaging in any

trade or business. See 26 USCS § 162. However, the deduction of losses in excess of profits is

disallowed when the activity engaged in is not a for-profit activity. See 26 USCS § 183.

For-profit activities.

The federal regulations list nine nonexclusive factors to aid in determining whether an

activity is a for-profit activity or not. See 26 CFR 1.183-2. These factors are: 1) the manner in

which the person carries on the activity; 2) the expertise of the person and his advisors; 3) the

time and effort put into the activity; 4) the expectation that assets may appreciate in value; 5) the

person’s success in carrying on similar or dissimilar activities; 6) the history of income or loss

David Gonzales
Letter ID No. L0832592944
page 6 of 11
with respect to the activity; 7) the amount of profits earned; 8) the financial status of the person;

and 9) the elements of personal pleasure and recreation. See id.

The manner in which a person engages in an activity has to do with the formality and

normal business practice used. See id. The Taxpayer did not have a formal business plan for his

cattle operation. He did maintain a separate bank account, but there was not sufficient evidence

that he kept formal records and tracked the use of the money in a way that is consistent with

normal business practices. Therefore, this factor weighs against finding that the operation was

for-profit.

Preparation, study, and consultation of experts can indicate that the activity is engaged in

for-profit. See id. The Taxpayer’s family was actively engaged in cattle ranching for part of his

childhood. Members of the Taxpayer’s extended family are also engaged in ranching, and the

Taxpayer has several friends involved in the cattle business. The Taxpayer regularly speaks to

his friends and family about the cattle operation. The Taxpayer is also a member of a cattle-

owner’s association and regularly attends lectures and seminars. However, there was not

sufficient evidence that the Taxpayer engaged in serious discussions with the intent to improve

his cattle operation. The evidence indicated that the Taxpayer’s interactions with friends and

family were more casual and social than they were seeking expert advice on his operation.

Therefore, this factor weighs against finding that the activity was for-profit.

The Taxpayer expends a substantial amount of time and effort in his cattle operation.

The Taxpayer works at least 20 hours a week with his cattle and often has to work outside during

extreme weather. This factor weighs in favor of finding that the activity is for-profit.

David Gonzales
Letter ID No. L0832592944
page 7 of 11
The Taxpayer hopes that his cattle will be profitable in the future. There is certainly a

possibility that the cattle will appreciate in value, depending on several market variables. This

factor weighs in favor of finding that the activity is for-profit.

The Taxpayer presented no evidence to indicate that he had success in carrying on other

similar or dissimilar business activities. Before beginning the cattle-breeding operation, the

Taxpayer was leasing cows for roping, but he indicated that the roping-cattle operation was not

profitable and was abandoned for that reason. This factor weighs against finding that the activity

is for-profit.

The Taxpayer has a history of substantial losses and very little to no income with respect

to the cattle operation. The Taxpayer characterized his best years as “breaking even”. However,

there were several circumstances which were beyond the Taxpayer’s control, such as the severe

drought, that influenced the cattle operations ability to make a profit. See id. This factor weighs

neutrally in finding that the activity is for-profit.

The Taxpayer sold some cattle for a very small profit during some years, and sold other

cattle for a very large loss most of the time. These types of occasional small profits, when the

activity generates substantial losses, are not indicative of for-profit activities. See id. This factor

weighs against finding that the activity is for-profit.

The Taxpayer is not reliant on the cattle operation for his livelihood. The Taxpayer has a

full-time job with DOT, which provides him with income to live on and to run his cattle

operation. This factor weighs against finding that the activity is for-profit.

The Taxpayer admitted that the cattle operation is a source of personal enjoyment for

him. The Taxpayer considers the cattle operation to be a stress-reliever from his job with DOT.

This factor weighs against finding that the activity is for-profit.

David Gonzales
Letter ID No. L0832592944
page 8 of 11
Six of the nine factors weigh against finding that the Taxpayer is engaged in the cattle

operation for-profit. Therefore, the Department’s disallowance of the deduction was reasonable,

and the Taxpayer failed to overcome the presumption that the assessment is correct. See NMSA

1978, § 7-1-17.

Assessment of Penalty.

Penalty “shall be added to the amount assessed” when a tax is not paid on time due to

negligence. See NMSA 1978, § 7-1-69 (2007) (emphasis added). However, a taxpayer will

generally not be negligent when the taxpayer relied on advice from tax counsel or an accountant.

See 3.1.11.11 NMAC (2001). The Taxpayer consulted with Mr. Mote on his tax liability, and

Mr. Mote prepared the Taxpayer’s returns. Mr. Mote is not an attorney or an accountant, but he

is an Enrolled Agent. Mr. Mote advised the Taxpayer to take the deductions that have now been

disallowed. Based upon the totality of the circumstances, the Taxpayer was not negligent.

Therefore, the penalty is hereby abated.

Assessment of Interest.

Interest “shall be paid” on taxes that are not paid on or before the date on which the tax is

due. NMSA 1978, § 7-1-67 (A). The word “shall” indicates that the assessment of interest is

mandatory, not discretionary. See Marbob Energy Corp. v. N.M. Oil Conservation Comm’n.,

2009-NMSC-013, ¶ 22, 146 N.M. 24. The assessment of interest is not designed to punish

taxpayers, but to compensate the state for the time value of unpaid revenues. Because the tax

was not paid when it was due, interest was properly assessed.

CONCLUSIONS OF LAW

A. The Taxpayer filed a timely written protest to assessment issued under Letter ID

number L0832592944, and jurisdiction lies over the parties and the subject matter of this protest.

David Gonzales
Letter ID No. L0832592944
page 9 of 11
B. The Taxpayer’s cattle operation was not engaged in as a for-profit activity. See 26

CFR 1.183-2. Therefore, the deductions were properly disallowed. See 26 USCS §§ 162 and 183.

See also NMSA 1978, §§ 7-2-2 and 7-2-3.

C. The Taxpayer relied on advice from an Enrolled Agent when he claimed the

deductions. Therefore, the Taxpayer was not negligent. See 3.1.11.11 NMAC. Penalty is

HEREBY ABATED.

D. The Taxpayer failed to overcome the presumption that the assessment of tax and

interest was correct. See NMSA 1978, § 7-1-17.

For the foregoing reasons, the Taxpayer's protest is DENIED IN PART AND GRANTED

IN PART.

DATED: September 9, 2016.

Dee Dee Hoxie
DEE DEE HOXIE
Hearing Officer
Administrative Hearings Office
Post Office Box 6400
Santa Fe, NM 87502

NOTICE OF RIGHT TO APPEAL

Pursuant to NMSA 1978, § 7-1-25, the parties have the right to appeal this decision by

filing a notice of appeal with the New Mexico Court of Appeals within 30 days of the date

shown above. See Rule 12-601 NMRA. If an appeal is not filed within 30 days, this Decision

and Order will become final. A copy of the Notice of Appeal should be mailed to John Griego,

P. O. Box 6400, Santa Fe, New Mexico 87502. Mr. Griego may be contacted at 505-827-0466.

David Gonzales
Letter ID No. L0832592944
page 10 of 11
David Gonzales
Letter ID No. L0832592944
page 11 of 11