Tax Court Denies More Than $456,000 in Horse Business Losses: What Schumacher v. Commissioner Means for Hobby Loss Deductions
Working hard, developing expertise, and spending substantial time on an activity do not necessarily prove that the activity is a business for federal tax purposes. In Schumacher v. Commissioner, T.C. Memo. 2026 47, the United States Tax Court denied more than $456,000 in horse breeding and training losses after concluding that the taxpayers lacked an actual and honest objective of earning a profit.
The decision is important for taxpayers who report recurring losses from farming, horse activities, photography, content creation, crafts, consulting, racing, collectibles, or other activities that may provide substantial personal enjoyment. It shows that the Tax Court will examine how the activity is managed, whether financial results are monitored, and whether the taxpayer has a credible path toward profitability.
For an introduction to the governing rules, see my article Hobby vs Business Tax Rules: How the IRS Determines Deductible Expenses.
Key Takeaway: Time, effort, knowledge, and enthusiasm may support a profit motive, but they cannot overcome years of losses, weak financial records, commingled funds, no credible business plan, and no documented effort to improve profitability.
What Section 183 Does
Internal Revenue Code Section 183 limits deductions attributable to an activity that is not engaged in for profit. An activity generally must qualify as a trade or business under Section 162 or an income producing activity under Section 212 before the taxpayer may claim ordinary expenses and losses under those provisions.
The central question is not whether the activity produced a profit in a particular year. The question is whether the taxpayer conducted the activity with an actual and honest objective of earning an overall profit.
Treasury Regulation Section 1.183 2 identifies nine nonexclusive factors that the IRS and courts use to evaluate profit motive. No single factor controls, and the factors are not determined by simply counting how many favor each side. Objective conduct generally carries more weight than a taxpayer's statement that profit was intended.
The Schumacher Horse Activity
Keith and Rhonda Schumacher began operating Schumacher Quarter Horses in 2001 as a sole proprietorship. Their activity included breeding, raising, training, showing, and selling horses. They also grew alfalfa on part of their property to feed the horses and sold excess cuttings.
The Schumachers were not casual participants. Dr. Schumacher was a veterinarian with extensive experience around horses. He completed a twelve week horse training course and regularly consulted other members of the horse community. Mrs. Schumacher had also worked with and competed on horses for many years.
The couple devoted substantial time to the activity. Dr. Schumacher generally spent two to four hours each day caring for and training the horses despite working sixty hours or more each week in his veterinary practice. Mrs. Schumacher worked with the horses before and after her full time education job and sometimes spent the entire day on the activity during school breaks.
They also constructed an indoor riding arena on their property at a cost of approximately $230,000, allowing them to work with the horses throughout the year.
Those facts supported dedication and expertise. They did not, however, prove that the activity was managed for profit.
The Losses at Issue
Schumacher Quarter Horses had never produced an annual profit from its formation in 2001 through the years before the court. From 2010 through 2019, annual Schedule F losses ranged from $51,028 to $210,148.
The taxpayers reported the following losses for the years before the court:
| Tax Year | Gross Income | Operating Expenses | Schedule F Loss |
|---|---|---|---|
| 2017 | $18,138 | $179,459 | $161,321 |
| 2018 | $53,973 | $219,122 | $165,149 |
| 2019 | $98,550 | $228,458 | $129,908 |
| Total | $170,661 | $627,039 | $456,378 |
The losses offset wages, income from Dr. Schumacher's veterinary practice, and other income reported on the couple's returns. The IRS determined deficiencies totaling $191,179 and proposed accuracy related penalties totaling $33,520, subject to concessions and the final court computations.
The Horse Activity Did Not Qualify for the Safe Harbor
Section 183(d) provides a rebuttable presumption that an activity is engaged in for profit when gross income exceeds deductions in at least three of five consecutive years. Horse breeding, training, showing, and racing activities receive a more generous presumption when they produce a profit in at least two of seven consecutive years.
Schumacher Quarter Horses had never produced a profit. The taxpayers therefore could not use the horse activity presumption and had to establish profit motive under the full facts and circumstances analysis.
Failing the safe harbor does not automatically make an activity a hobby. A taxpayer may still prove a genuine profit objective through businesslike operations, financial analysis, expert advice, operational changes, and other objective evidence.
How the Tax Court Applied the Nine Factors
| Profit Motive Factor | Court Result | Important Evidence |
|---|---|---|
| Manner in which the activity was conducted | Favored the IRS | Incomplete records, commingled funds, no business plan, and no meaningful profitability analysis. |
| Expertise of the taxpayers or advisers | Favored the taxpayers | Extensive horse experience, veterinary knowledge, training, and industry discussions. |
| Time and effort devoted to the activity | Favored the taxpayers | Both taxpayers devoted substantial and consistent time to caring for and training the horses. |
| Expectation that assets would appreciate | Favored the IRS | No reliable inventory records or persuasive evidence of the horses' values and expected appreciation. |
| Success in other activities | Neutral | The taxpayers had professional success, but not in a sufficiently similar business. |
| History of income and losses | Favored the IRS | The activity incurred continuous and substantial losses for at least eighteen years. |
| Amount of occasional profits | Favored the IRS | The activity had never produced an annual profit. |
| Financial status of the taxpayers | Favored the IRS | Substantial income from other sources allowed the taxpayers to fund the activity and benefit from its losses. |
| Elements of personal pleasure | Favored the IRS | The taxpayers received substantial personal satisfaction from breeding, training, riding, racing, and showing horses. |
Six factors favored the IRS, two favored the taxpayers, and one was neutral. More importantly, the objective financial and operational evidence persuaded the court that the activity lacked a genuine profit objective.
Why the Taxpayers Lost
1The Records Were Designed for Tax Reporting
The taxpayers retained handwritten notes, receipts, and bank statements. The problem was not the complete absence of documentation. The problem was how the records were used.
The court concluded that the records were maintained for tax return preparation rather than for reducing expenses, evaluating performance, setting prices, or increasing profits. The taxpayers did not maintain a formal ledger, use accounting software, track expenses by horse, or prepare reliable financial analyses.
Records that merely allow a tax return to be completed are not as persuasive as records that demonstrate active business management.
2The Separate Bank Account Was Not Truly Separate
Schumacher Quarter Horses had a separate checking account. However, the taxpayers frequently paid horse expenses from their personal account and replenished the business account whenever it ran out of money. Their personal account also served as overdraft protection.
The court viewed the business account as an extension of the personal account. This demonstrates that opening a separate account is not enough. The account must actually be used to maintain financial separation and reliable business records.
3There Was No Credible Business Plan
A written business plan is not always required. A taxpayer may demonstrate an unwritten plan through actual conduct. In Schumacher, however, the court found neither a written plan nor persuasive evidence of an unwritten plan.
The taxpayers could not demonstrate how horse sales, breeding fees, training revenue, competitions, asset appreciation, or other income sources would eventually exceed the operation's substantial costs.
4The Taxpayers Did Not Respond to Continuing Losses
The taxpayers testified that they made changes to their breeding and training strategies. The court was not persuaded that the changes were designed to increase profits rather than improve competitive performance.
There was little evidence that the taxpayers reduced expenses, changed pricing, discontinued unsuccessful activities, developed new revenue sources, or analyzed which horses and activities were profitable.
5The Loss Period Was Too Long to Explain as a Startup Phase
Horse breeding businesses may require a longer startup period than many other activities. The Tax Court has previously recognized that a startup period of five to ten years may be reasonable for certain horse breeding operations.
Schumacher Quarter Horses had incurred losses for at least eighteen years. The taxpayers did not provide evidence showing that the activity remained in a legitimate startup or development period.
6Asset Appreciation Was Not Documented
A taxpayer may establish an overall profit objective by showing that expected appreciation in land, breeding stock, or other assets could exceed operating losses.
The Schumachers did not provide reliable inventory records, valuations, appraisals, or other evidence allowing the court to determine the value of their horses or the amount of expected appreciation. Without that evidence, the appreciation factor favored the IRS.
Hard Work and Expertise Were Not Enough
The court recognized that the taxpayers had extensive knowledge and devoted substantial time to the horses. Those factors favored them. The court also acknowledged that they took exceptional care of the animals.
Those favorable facts did not overcome the weak financial evidence. Section 183 focuses on whether the taxpayer is pursuing profit, not merely whether the taxpayer is serious, skilled, or hardworking.
This distinction is particularly important for activities that involve personal interests. A taxpayer may be highly committed to an activity and still fail to operate it as a business.
The Taxpayers Avoided the Penalties
Although the court sustained the hobby loss determination, it did not uphold the Section 6662 accuracy related penalties.
The Schumachers had used the same accountant and enrolled agent for approximately twenty years. Each year, they specifically discussed Section 183 with him. He advised them that the horse activity satisfied the profit motive requirements despite its history of losses.
The court applied the professional reliance principles under Section 6664 and Treasury Regulation Section 1.6664 4. The taxpayers established that:
- The adviser was a competent professional with sufficient expertise.
- The taxpayers provided the adviser with the necessary and accurate information.
- The taxpayers actually relied in good faith on the adviser's judgment.
As a result, the court found reasonable cause and good faith and removed the proposed penalties.
Important Distinction: Reliance on a tax professional may provide relief from a penalty, but it does not transform a hobby into a business or restore deductions that are not otherwise allowable.
What Hobby Classification Means Under Current Law
Hobby income remains taxable. The deduction result is substantially less favorable.
Section 183(b) permits certain deductions that would be allowable without regard to whether the activity was conducted for profit. Examples may include qualifying mortgage interest and property taxes, subject to the separate rules and limitations that govern those deductions.
Other expenses that would be deductible only if the activity were a business are generally treated as miscellaneous itemized deductions for an individual. Examples may include supplies, advertising, travel, training, utilities, insurance, and similar operating costs.
Section 67(h) now permanently disallows miscellaneous itemized deductions for taxable years beginning after 2017. Therefore, most ordinary hobby expenses are not deductible by an individual for federal income tax purposes, even when the activity produces taxable income.
This can produce a harsh result. A taxpayer may have taxable hobby income while receiving little or no federal deduction for the expenses incurred to generate that income.
Steps That Can Strengthen a Profit Motive Position
Taxpayers reporting recurring losses should build evidence of profit motive before an IRS examination begins.
- Maintain complete accounting records using reliable bookkeeping software.
- Use separate business checking and credit card accounts for all activity transactions.
- Prepare a written business plan explaining revenue sources, expected costs, and the path to profitability.
- Prepare annual budgets, forecasts, and cash flow projections.
- Review profit and loss statements throughout the year rather than only at tax return time.
- Track revenue, direct costs, and profitability by product, service, animal, project, or customer.
- Document pricing decisions and comparisons with profitable competitors.
- Record cost reduction efforts and changes made in response to losses.
- Retain evidence of advertising, customer development, and sales activity.
- Maintain calendars and time records showing work performed.
- Obtain appraisals or valuation evidence when asset appreciation is part of the expected overall profit.
- Document consultations with industry, business, and tax advisers.
For a detailed record list, see The Best Records to Keep for an IRS Hobby Loss Audit.
How Schumacher Compares with Taxpayer Victories
Taxpayers can prevail in hobby loss cases even after reporting losses for many years. Successful cases generally involve stronger evidence of professional management, market research, financial analysis, expert consultation, operational changes, and expected asset appreciation.
The difference is often not whether the taxpayer worked hard. The difference is whether the taxpayer can demonstrate that decisions were made to create an overall economic profit.
My article How to Win an IRS Hobby Loss Audit: Lessons from Tax Court Cases compares cases in which taxpayers successfully proved a profit motive with cases in which the court found that the activity was primarily personal.
Frequently Asked Questions
Does reporting losses for several years automatically make an activity a hobby?
No. Repeated losses are an important factor, but they do not automatically determine the result. The IRS and courts consider all relevant facts, including the nature of the activity, its normal startup period, recordkeeping, business planning, operational changes, and the taxpayer's efforts to improve profitability.
Does a separate business bank account prove a profit motive?
No. A separate account is helpful only when it is consistently used to maintain genuine separation between personal and business finances. The Schumacher taxpayers had a business account, but frequent transfers and personal payments weakened its value as evidence.
Can professional tax advice protect the deductions?
Professional advice does not make an otherwise personal activity a business. It may support relief from accuracy related penalties when the adviser is competent, receives complete and accurate information, and provides advice on which the taxpayer reasonably relies in good faith.
Are hobby expenses deductible under current law?
Most ordinary hobby expenses are not deductible by individuals because Section 67(h) disallows miscellaneous itemized deductions for taxable years beginning after 2017. Expenses that are independently deductible under another Code provision may remain available, subject to that provision's requirements and limitations.
Does personal enjoyment automatically make an activity a hobby?
No. A profitable business can also be enjoyable. Personal pleasure becomes more damaging when the taxpayer lacks business records, financial analysis, operational changes, and other objective evidence of a profit motive.
Final Takeaway
Schumacher v. Commissioner demonstrates that substantial effort and expertise do not replace business discipline. The taxpayers cared for the horses, improved their skills, invested in facilities, and devoted substantial time to the operation. They still lost because they could not demonstrate that the activity was managed with an actual and honest objective of earning an overall profit.
Taxpayers with recurring Schedule C or Schedule F losses should not wait for an IRS audit to evaluate their position. A review of accounting records, pricing, operating decisions, financial projections, and documentation can identify weaknesses while there is still time to correct them.
Technical References
- Internal Revenue Code Section 183, Activities Not Engaged in for Profit.
- Treasury Regulation Section 1.183 2, Profit Motive Factors.
- Internal Revenue Code Section 67, Miscellaneous Itemized Deductions.
- Internal Revenue Code Section 6662, Accuracy Related Penalties.
- Internal Revenue Code Section 6664, Reasonable Cause and Good Faith.
- Treasury Regulation Section 1.6664 4, Reasonable Cause and Good Faith Exception.
Review Repeated Business Losses Before an IRS Audit
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