Watch How You Account for Your “Entity”

The Tax Court released the Barnhart Ranch, Co case yesterday and it is good reminder of why it is important to treat your “entity” separate from personal activities.  The facts of the case are as follows:

  • Two Texas brothers had a ranching operation.  Many years ago, they had set up a corporation (Barnhart Ranch, Co.) to handle all of the sales, expenses, payroll of the ranching operation.  The brothers and their family individually (or in partnership) owned two ranches that were leased to the Barnhart Ranch Co but also had various oil and gas interests along with numerous real estate holdings.
  • The brothers used a “joint interest accounting system” (which is very common in the oil and gas business) for their ranch operations.  Under this system, the ranch would account for all of the income and expense and then on a monthly basis write a check to each brother for their half of the net income of the operation (or the brothers would write a check back if there was a loss).
  • They had done this for several years and actually been through a couple of audits where the IRS took a quick look at the corporation and made no changes.
  • This income or loss was reported on their individual tax returns by filing Schedule C.  Not sure why they did not file Schedule F.  Things went well until they showed large losses from the ranch in 2010-2012.  The IRS audited their personal returns and assessed additional tax and penalties that totaled over $1 million for the brothers and the corporation.

The brothers tried to argue that the corporation was their agent.  However, all of the operations and the holding out to the public was done in the name of the corporation.  The brothers made a couple of other arguments, but the bottom line is the corporation was the owner of the cattle and all of the income and loss should have been reported at its level.  The corporation could not deduct the losses, but the brothers could.  The Court ruled in favor of the IRS.

The interesting part to me is that the Court also ruled in favor of the IRS on the penalties that were assessed (over $200,000 of penalties).  Since the brothers had done this accounting method for several years and had been consistent, I would have thought  the Court may waive the penalties, but they did not.  I have a feeling that the brothers may have been a little “heavy handed” with the Court and since the Court viewed them as sophisticated taxpayers, they threw the book at them, so to speak.

Also, I do not see where the Court addressed whether there should have been additional dividend income to the brothers.  With a C corporation, any distributions to the owners normally yield dividend or capital gains status, but I did not see this addressed (maybe that will be another Court case).

The  bottom line is treat your entity as an entity separate from you.  If you don’t the IRS may come calling.

CliftonLarsonAllen, LLP

  • Principal
  • CliftonLarsonAllen
  • Yakima, Washington
  • 509-823-2920

Paul Neiffer is a certified public accountant and business advisor specializing in income taxation, accounting services, and succession planning for farmers and agribusiness processors. Paul is a partner with CliftonLarsonAllen in Yakima, Washington, as well as a regular speaker at national conferences and contributor at agweb.com. Raised on a farm in central Washington, he has been immersed in the ag industry his entire life, including the last 30 years professionally. In fact, Paul drives combine each summer for his cousins and that is what he considers a vacation.

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