Could Sonja Foote deduct cattle-breeding losses when seven of the nine federal profit-motive factors weighed against treating the ranch as a business?

Plain-English summary

Sonja Foote could not deduct her cattle-operation losses because seven of the nine federal profit-motive factors weighed against treating the activity as a for-profit business. The AHO upheld $5,958.00 tax, $1,191.60 penalty, and $552.05 interest for 2011 through 2013.

Foote and her husband bought about 1,300 acres in Quay County in 2009. They improved the property with fencing and wells, bought three cows, and began a cattle-breeding operation.

By the hearing, the herd had grown to 19 pairs of heifers and calves. Foote planned to continue breeding until it reached 50 head, which she believed the land could reasonably sustain. The operation and improvements generated substantial losses that she claimed against income.

New Mexico followed the federal profit-motive rules

New Mexico personal income tax begins with federal adjusted gross income. Section 162 allowed ordinary business expenses, but Section 183 disallowed losses exceeding income when an activity was not engaged in for profit.

The parties agreed that the federal nine-factor test in 26 C.F.R. § 1.183-2 controlled whether the cattle operation was a business.

Seven factors weighed against a profit motive

The AHO evaluated each factor:

1. Businesslike manner—against. Foote kept receipts, but showed no formal business plan or separate bank account. She said bookkeeping was improving but produced no example of the new system.
2. Expertise—against. Ranching relatives and knowledge of range management did not establish extensive study or expert consultation.
3. Time and effort—against. No evidence showed Foote's own management time or that she hired others to run the operation.
4. Asset appreciation—in favor. The herd had grown, the land had appreciated, and the cattle might appreciate depending on market conditions.
5. Success in other activities—against. Foote showed no success in similar or different businesses.
6. History of income or loss—neutral. The operation had substantial losses and no shown income history, but losses can occur while a breeding herd is being built.
7. Amount of profit—against. Her representative believed the ranch had recently become profitable, but no evidence established actual profit.
8. Financial status—against. Foote depended on her husband's substantial outside earnings and later retirement income, not the cattle operation.
9. Personal pleasure or recreation—against. The record contained no evidence about whether Foote personally enjoyed the activity.

With seven factors against, one favorable, and one neutral, Foote did not overcome the assessment's presumption of correctness.

Penalty and interest remained due

Section 7-1-69 made penalty mandatory when late payment resulted from negligence. Regulation 3.1.11.10(C) included inadvertence, mistake, and erroneous belief within negligence.

Section 7-1-67 likewise required interest on tax not paid when due. The AHO treated interest as compensation for the time value of unpaid revenue rather than punishment.

Result: protest DENIED. The cattle losses were disallowed, and the full assessment remained.

What this means for you

Ranchers and small agricultural operations

Land ownership, improvements, herd growth, and long-term hopes are not enough by themselves. Document a concrete business plan, operating decisions, time spent, professional advice, income history, and changes made to improve profitability.

Taxpayers with startup losses

Losses during a genuine startup phase are not automatically fatal. Here that factor was neutral, but the taxpayer still lost because most of the other evidence did not show businesslike operation or profit intent.

Accountants and return preparers

Keep support for every federal Section 183 factor rather than relying solely on receipts. Expense records establish amounts, but they do not alone prove that the activity was conducted for profit.

Common questions

Q: Did the AHO ignore appreciation in the land and herd?
A: No. It treated asset appreciation as the single factor favoring a profit motive.

Q: Were repeated losses automatically disqualifying?
A: No. The AHO treated the loss history as neutral because cattle breeding can require a multiyear startup period.

Q: Did keeping receipts prove a business?
A: It helped show expenses, but the lack of a business plan, separate account, and demonstrated improved bookkeeping caused the business-manner factor to weigh against Foote.

Q: How many factors weighed against Foote?
A: Seven weighed against, asset appreciation favored her, and the history-of-loss factor was neutral.

Q: What assessment was upheld?
A: $5,958.00 tax, $1,191.60 penalty, and $552.05 interest for 2011 through 2013.

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 — definition of tax and assessment presumption
• NMSA 1978, §§ 7-1-67 and 7-1-69 — interest and negligence penalty
• Regulations 3.1.11.8 and 3.1.11.10(C) NMAC — penalty and negligence

Cases cited:

• Holt v. New Mexico Department of Taxation and Revenue, 2002-NMSC-034 — Department authority to examine and recalculate taxable income
• Public Services Co. v. New Mexico Taxation and Revenue Department, 2007-NMCA-050 — taxpayer's burden to prove a deduction
• Sec. 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: Sonja Foote
• Decision PDF: D&O 16-47

Original ruling text

STATE OF NEW MEXICO
ADMINISTRATIVE HEARINGS OFFICE
TAX ADMINISTRATION ACT

IN THE MATTER OF THE PROTEST OF
SONJA FOOTE, No. 16-47
TO ASSESSMENT ISSUED UNDER
LETTER ID NO. L1859893808

DECISION AND ORDER

A formal hearing on the above-referenced protest was held on August 25, 2016 before

Hearing Officer Dee Dee Hoxie. Hearing Officer Chris Romero was also present. The Taxation and

Revenue Department (Department) was represented by Mr. Marek Grabowski, Staff Attorney. Mr.

Nicholas Pacheco, Auditor, also appeared on behalf of the Department. Mr. Douglas Mote, Enrolled

Agent, appeared for Sonja Foote (Taxpayer) as her representative. The Taxpayer was given

additional time to submit evidence. The Taxpayer’s deadline was September 2, 2016. A timely

supplemental brief was submitted. The Department was given until September 9, 2016 to respond.

A timely response was submitted. 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 April 11, 2016, the Department assessed the Taxpayer for personal income tax, penalty,

and interest for the periods from January 1, 2011 through December 31, 2013. The

assessment was for $5,958.00 tax, $1,191.60 penalty, and $552.05 interest.

2. On May 2, 2016, the Taxpayer filed a formal protest letter.

3. On June 21, 2016, the Department filed a Request for Hearing asking that the Taxpayer’s

protest be scheduled for a formal administrative hearing.

4. On June 23, 2016, the Hearings Office issued a notice of hearing. The hearing date was set

within ninety days of the protest.

5. On July 15, 2016, a telephonic scheduling hearing was conducted.

6. On July 19, 2016, the Hearings Office issued the scheduling order and notice of hearing.

7. The Taxpayer and her husband owned approximately 1300 acres of land in Quay County,

New Mexico. They purchased the land in 2009.

8. The Taxpayer’s husband earned a substantial income from work unrelated to their land and

cattle. The Taxpayer’s husband retired, became ill, and passed away prior to the assessment.

9. The Taxpayer made improvements to the land, which included fencing and drilling wells.

The Taxpayer bought three cows and began a cattle-breeding operation.

10. The Taxpayer’s herd now has 19 pairs of heifers and calves. The Taxpayer intends to

continue breeding until her herd is 50 head, which she believes can be reasonably sustained

on her land.

11. The Taxpayer has family who also engage in ranching. The Taxpayer has witnessed bad

range management in the past, and that is part of the reason she intends to keep her herd

fairly small.

12. The Taxpayer’s cattle-breeding operation and land improvements have generated substantial

losses, which the Taxpayer claimed against her income.

13. The Taxpayer kept receipts relating to the operation and provided copies of receipts to the

Department.

14. The Taxpayer has recently taken steps to improve her bookkeeping and is now integrating her

financial information into a computer. The Taxpayer did not provide any examples of her

improved system.

15. The Taxpayer did not provide any evidence to show that the operation has made a profit.

Sonja Foote
Letter ID No. L1859893808
page 2 of 8
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 operation should be considered as a

for-profit business or not under 26 USCS § 183. The Taxpayer argues that looking at the nine factors

is not sufficient to determine if an activity is for-profit. The Taxpayer argues that personal

observation of the operation itself is necessary and that few activities would hold up as for-profit if

looked at solely on paper. The Taxpayer also argues that the land has appreciated substantially in

value and that the appreciation should weigh heavily in favor of finding that 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 land appreciation is too speculative and is not enough to

prove that the cattle operation is for-profit. The Department also requested that the decision be held

in abeyance because the Taxpayer’s supplemental brief raised questions about the Taxpayer’s income

and the deductions that the Department had allowed when it made the assessment. The request is

denied. The scope of this protest is limited to the assessment that was made on April 11, 2016.

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 she is entitled to an

abatement.

The burden is on the taxpayer to prove that she 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.

Sonja Foote
Letter ID No. L1859893808
page 3 of 8
See also Till v. Jones, 1972-NMCA-046, 83 N.M. 743. “Where an exemption or deduction 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 her losses from the operation of

her 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 her 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 with respect to

Sonja Foote
Letter ID No. L1859893808
page 4 of 8
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. There was no evidence that the Taxpayer had a formal business plan

for her cattle operation. There was no evidence that the Taxpayer maintained a separate bank

account for the operation. There was evidence that the Taxpayer kept track of her expenses and kept

receipts for those transactions. Based upon the totality of the evidence, 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. The Taxpayer

learned about range management and ways to prevent overgrazing, but there was no evidence that the

Taxpayer engaged in extensive study or expert consultation. Therefore, this factor weighs against

finding that the activity was for-profit.

There was no evidence that the Taxpayer personally spends her time and effort on

maintaining the operation. There was no evidence that the Taxpayer hired others to manage the

operation. Given the lack of evidence presented, this factor weighs against finding that the activity is

for-profit.

The Taxpayer’s herd has increased, and the land has appreciated in value. There is certainly

a possibility that the cattle will also 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 she had success in carrying on other

similar or dissimilar business activities. This factor weighs against finding that the activity is for-

profit.

Sonja Foote
Letter ID No. L1859893808
page 5 of 8
The Taxpayer has a history of substantial losses with respect to the cattle operation. There

was no evidence of the history of income with respect to the operation. However, it is not unusual

for a business to experience substantial losses and little profits when it is in the start-up phase. It can

take several years to build up a herd since cows are bred every two years. This factor weighs

neutrally in finding that the activity is for-profit.

Mr. Mote believes that the Taxpayer’s operation has been turning a profit for the last two

years. However, there was no evidence presented to show that the Taxpayer has actually earned any

profits from the business. Even 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 her livelihood. The Taxpayer relied

upon her husband’s income and now his retirement income for her support. This factor weighs

against finding that the activity is for-profit.

There was no evidence whether the Taxpayer found personal enjoyment out of the cattle

operation or not. This factor weighs against finding that the activity is for-profit.

Seven 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). The word “shall” indicates that the

assessment of penalty is mandatory, not discretionary. See Marbob Energy Corp. v. N.M. Oil

Conservation Comm’n., 2009-NMSC-013, ¶ 22, 146 N.M. 24. Assessments of penalty are presumed

Sonja Foote
Letter ID No. L1859893808
page 6 of 8
to be correct and it is a taxpayer’s burden to show that the assessment was not correct. See 3.1.11.8

NMAC (2001). See NMSA 1978, § 7-1-17. See also El Centro, 1989-NMCA-070. Negligence

includes inadvertence, mistake, and erroneous belief. See 3.1.11.10 (C) (2001). Therefore, penalty

was properly assessed.

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). Again, 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 L1859893808, and jurisdiction lies over the parties and the subject matter of this protest.

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 failed to overcome the presumption of correctness. See NMSA 1978, §

7-1-17.

For the foregoing reasons, the Taxpayer's protest is DENIED.

DATED: September 28, 2016.

Dee Dee Hoxie
DEE DEE HOXIE
Hearing Officer
Administrative Hearings Office
Sonja Foote
Letter ID No. L1859893808
page 7 of 8
Post Office Box 6400
Santa Fe, NM 87502

Sonja Foote
Letter ID No. L1859893808
page 8 of 8