Insurance
Insurance, Pros & Cons
Lawsuits, Liability
Preparing for a Hobby Loss Challenge
Tax Audits, Avoiding Red Flags
Tax Audits, Preparing For
Tax Hobby-Loss Rules (Spring 2006)
Planning Against a Hobby Loss Challenge (Fall 1996)
Tax Implications on Selling Horses
Tax Q & A
Taxes, Passive Participation
Tax-saving Tips
Trusts, Forming
Vanning Liabilities
An Overview of Equine Insurance
By Ray Hemphill
Ownership of thoroughbreds, whether for racing or breeding, is a past time that can be the source of great personal pleasure and financial reward. However, like most pursuits in life, it also can be a financial risk that goes well beyond one's expectation and intended budget. With exposures to liability for bodily injury and property damage as well as property loss, the prudent horse owner should minimize his or her risk either by obtaining insurance, transferring the risk, or by implementing a disciplined self-insurance program.
Whether a person owns one horse or one hundred, the predominant goal should be the aversion of liability for bodily injury or property damage caused by one's horse. While an owner may be able to sustain the loss of a horse, it may be an entirely different matter should one be named as a defendant in a lawsuit.
It has been my experience that many owners believe that their liability exposure from horse racing is assumed either by their homeowner's policy or by the racing facility's policy where the horse is stabled. While there may be some logic in those beliefs, they are in general untrue. At best, a homeowner's policy may concede some coverage (i.e., defense costs,) and although the trainer and racetrack may be held jointly liable, these circumstances may only decrease an owner's share of liability.
Types of Coverage
Commercial General Liability: Ownership of thoroughbreds, whether for racing or breeding, is usually considered a "business" by both government agencies and insurance companies alike. Therefore, to properly insure against liability exposure arising from the "business" an owner should obtain an insurance policy that specifically provides Commercial General Liability ("CGL"), and clearly notes equine business activities. Such policies are often rated by the number of horses owned, and will usually provide coverage at most locations where a horse may race or train. It is important, however, to advise your agent of any out-of-state activities, or of additions or deletions to your schedule of horses.
The cost of a CGL policy is relatively small. For example, a policy insuring an owner with four horses, with a liability limit of $1 million, should cost between $250 and $500 per year.
Excess Insurance: Another consideration in the evaluation of one's liability exposure is the adequacy of the "policy limits." Generally speaking, we recommend no less than a $1 million limit, although higher limits may be more appropriate for some owners. The decision to obtain additional or "excess" coverage is largely a subjective matter. One should consider such factors as total net worth, pending judgments, acquisitions, and celebrity, in making the decision. Excess liability policy, supplementing policy limits in increments of $1 million. The cost of an excess policy may be $1,000 for the first $1 million, $750 for the second $1 million, $500 for the third $1 million and so forth.
Mortality Insurance: While liability claims represent the greatest threat to an owner's financial well being, the loss of a valued horse can also be the cause of significant monetary loss. Some owners of large stables may be better able to absorb such losses through tax mechanisms; however, most owners suffer the loss of their investment without any relief from the IRS. To protect themselves from this risk, owners may purchase equine mortality insurance. These policies are relatively easy to understand, and usually insure against all injuries and illnesses that result in death. Interestingly, many of these policies also include coverage against theft.
In recent years, the marketplace for equine insurance has been highly competitive, and rates for racehorses, (except geldings) has hovered at around 5 percent of the value insured. Better deals are frequently available for higher valued horses, or to those owners with a significant number of insured horses.
In addition to "all-risk" mortality insurance, other forms of coverage are available. A policy for Specified Perils may be purchased, although coverage is limited to, in general, the perils of fire, wind, lightning, and the hazards of transportation. However, the policy offers no coverage for illness or training accidents. Also available, although not usually for racing animals, are endorsements to the mortality policy for medical and surgical coverage to an agreed limit.
Claiming Insurance: Other variations of equine mortality insurance include deductible policies and claiming coverage. The latter provides coverage to the owner who desires to claim a horse. In such cases, the owner is covered for the horse claimed from the time the starting gate opens until 24 hours thereafter. Deductible policies are available to owners of larger stables only, and they provide for a substantial reduction of the premium rate in exchange for a large aggregate deductible so that both the owner and the insured share in the risk.
Pitfalls
Valuation: Although equine mortality policies are relatively uncomplicated, an owner should be aware of certain pitfalls. Perhaps the most misunderstood elements of a mortality policy, is the concept of "valuation at the time of loss." The vast majority of mortality policies provide for Actual Cash Value of the horse at death. This can make for an unpleasant situation if either an owner or one's agent has neglected to value the horse properly. The situation can be avoided by obtaining a policy with an agreed value endorsement. Many insurers are reluctant to offer such endorsements, yet a number of companies will if provided a formal appraisal.
Notice Requirements: Another pitfall to the owner is the notification provision requiring prompt notice to the insurer of illness or injury. The policy wording clearly states that it is the responsibility of the owner to notify the company or its agent immediately if there is anything abnormal as to a horse's health. It is therefore incumbent upon the owner to advise anyone who may be caring for the insured horse that they must advise the owner of any health problems.
Owners should also be aware that most mortality policies include a provision about claiming races. This provision states that the value of the insured horse will automatically drop to the value of the last claiming race in which it ran. For example, if a horse was purchase and insured for $75,000, but later runs for a price of $32,000, the insured value automatically becomes $32,000. Under such circumstances, the owner is entitled to a pro rata return of a portion of the premium.
Other coverage that may effect a thoroughbred owner include horse legal liability (care, custody or control) and Worker's Compensation.
For most thoroughbred owners, insulation from the inherent risks of the sport may be accomplished easily and at modest cost. Once properly protected from loss, the owner can more fully enjoy the thrills and drama of thoroughbred racing without the gnawing concern of financial threat.
To Insure or Not
By Richard W. Craigo
So, you’ve finally decided to take the plunge and buy a racehorse. Congratulations! Now it’s time to decide whether or not you want to protect your investment via insurance. Top equine attorney Richard Craigo has kindly written the following piece to help you make a wise decision in the area of horse insurance.
For the owner of a Thoroughbred at the track, it’s important to first understand that racehorses “in-training” can only be covered for mortality purposes. Loss of use, medical, surgical, and fertility insurance cannot be purchased for such horses, although such coverages can be purchased for a horse after it’s racing days are over, or as a young horse before it’s put into training. Mortality insurance rates range from 4-5% of the horse’s value for colts and fillies, and around 5-6% for geldings.
My general philosophy is for my clients to insure only those risks that will, if they occur, result in substantial financial harm to the owner. Insurance coverages should not be carried on run-of-the-mill risks that the owner can readily afford. After all, anyone engaging in Thoroughbred ownership should be prepared to absorb some losses, including the untimely loss of a horse of modest value. This simply goes with the territory.
Virtually all of my clients who began their horse businesses by insuring every horse invariably do, over the years, realize the substantial cost of such insurance and eventually begin to be very selective in their insurance habits.
Having said that, there are two situations in which insurance is a very good, if not almost mandatory, investment. The first, and most obvious, is protection against a risk which makes up a substantial portion of the owner’s net worth. There are very few owners who can readily absorb the loss of a multi-million-dollar horse, and insurance is, in most cases, a must.
The second situation is where, even though the loss would not be catastrophic to the owner, there is such a pronounced income tax benefit that insurance coverage makes good economic sense. I’ll explain this later.
Here are three basic suggestions to consider before any insurance is purchased.
First, find an agent in whom you have confidence, and who will freely communicate with you. California is blessed with several excellent horse insurance agents. If you have no one in mind, TOC can give you names of reputable agents. Second, make sure that any policy purchased is placed with a reputable insurer both in terms of financial ability to pay a claim, and in terms of their reputation for settling legitimate claims without a hassle. Third, be sure to have your agent compare policies and explain their provisions to you, as the devil is often in the details.
Important Policy Provisions
When purchasing a mortality policy, make sure that the following two features are included. First, ask that the policy have an “agreed value*” on the horse so that in the event of its death, the often contentious attempts at valuation of the animal are avoided. After all, the insurance company, with its superior assets, will almost always win that battle. Second, review the policy’s “renewal conditions**” so that if a horse becomes seriously ill or injured during the policy period, you are aware of your renewal options while the fate of the animal is being determined.
Another feature to be considered is a “stable rate,” meaning that one receives a discount of up to 10% if every horse in the “stable” is insured. Needless to say, I do not recommend such coverage, as it flies in the face of the general philosophy set forth above, which urges individuals to insure only against catastrophic risks. But if an owner is inclined to insure numerous horses, perhaps for fear of a barn fire or disease killing all of them, then I would recommend a “deductible” policy. Provision for a healthy deductible in the event of a loss can lower the premiums substantially.
Tax Planning Considerations
As referred to earlier, there is one situation in which mortality insurance coverage is very likely in the owner’s best interest, even though the loss would not be catastrophic. This occurs when the potential taxable gain, which would be realized in the event of death, would constitute a long-term capital gain at the favorable 20% federal income tax rate. The fact that the insurance premiums are deductible at a rate of 40% may make such coverage economically wise.
For example, assume an owner has purchased a horse for $100,000. Also assume that after holding the horse for the required 24 months for long-term capital gains, the horse is worth $200,000. Now assume that the owner insures the horse for $200,000, paying a $10,000 premium. That premium is deductible against other ordinary income and at the highest federal income tax bracket of about 40%. Thus the after-tax premium “cost” is only $6,000 (60% x $10,000). Assume now that the horse dies and $200,000 is collected. The $100,000 increase in value over the original cost will be taxed at only a 20% rate, or $20,000. Thus, the owner has paid the premium with fully tax-deductible dollars in order to obtain a return subject to only a highly favorable 20% tax rate - an economically sound result.
There is one final income tax advantage of insurance. The Internal Revenue Code provides that an owner collecting insurance proceeds from the death of a horse due to “casualty,” may forego the payment of tax on gain realized, provided that the proceeds are invested within the following two taxable years in property “similar or related in service or use,” to the deceased horse.
Summary
Thoroughbred insurance coverage should, in most cases, be limited to situations which would be near catastrophic for the particular owner. The exception to this philosophy is where the proceeds from insurance would qualify for favorable long-term capital gains treatment.
If you do decide to insure your horse, remember to engage a reputable agent, to deal only with reputable insurance companies, and to carefully review the policy. Following such course of action will allow you some peace of mind that you have soundly protected your investment in the unlikely event that a catastrophe occurs.
Richard Craigo practices equine law in Los Angeles, California. He is a past-president of the California HPBA, and is certified as a Tax Specialist by the State Bar of California Board of Legal Specialization.
Racing's Responsibilities
By Piers Plunket
(*The views expressed in this article are those of Mr. Plunket, and not necessarily those of TOC.)
The recent decision in the highly publicized "Interwit" case, in which owners of a horse involved in a fatal mishap on the racetrack were able to recover financial restitution from the owner(s) of the horse that precipitated the accident, sadly illustrates how litigious the horse racing industry has become. More importantly, it should serve notice to participants that racing involves some inherent risks, and the use of the courts to remedy such situations that are beyond anyone's control ultimately undermines the entire industry's health.
Racehorse Ownership Involves Unique Exposures
Being the owner of a horse of any description carries many of the same responsibilities and encumbrances as any other pursuit save one huge difference, which alters the entire exposure. The object of most pursuits is inanimate, but, with horses, we are dealing with a living sentient being.
Most any pursuit can cause both property damage and/or bodily injury, but the incident is usually as the result of human intervention and error be it negligence, ignorance, or mechanical breakdown. Horses, on the other hand, can cause both property damage and/or bodily injury without any interference from man. With a will and mind of their own, all our safe guards may never be sufficient to eliminate the risk. Every participant or purveyor of the industry must recognize this fact.
It must also be remembered that, contrary to popular belief, the mere fact that an owner has transferred the care and protection of your horse(s) to another, be it a trainer or out to a farm, does not in the eyes of the law exonerate or remove you from blame and responsibility in the event that an incident were to occur. In this litigious "deep pocket" environment, racehorse owners are prime targets and may be held accountable in the rare event that something were to occur.
Lawsuits Threatening Health of Industry
Our legal atmosphere almost promotes for the filing of frivolous suits against anyone and everyone who could be considered to have some liability, however vague. Insult is then added to injury by awarding compensation with sometimes, ridiculous penalties. In the case of a horse striking someone totally unconnected to either the owner or the horse, for example a fan at the racetrack, the owner, who may not even reside in the state, could hardly be held accountable.
Of course legitimate negligence that results in either injury or damage should be pursued. However, most cases that could arise from the horse industry pit the plaintiff against the defendant who usually takes the form of an insurance company. Most of the historical rulings have found in favor of the plaintiff with the sad effect that rather than lose in court with the prospect of heinous punitive damages, the insurance company settles out of court in order to reduce the cost incurred by defending the case. This may reduce the pain, but only serves to deepen the wound with the precedent it sets. With insurance being increasingly used to remedy financial loss, a vicious cycle is created, which only serves to worsen the problem. In cases where an insurance company is not available, ideally, a decision should be sought for the principle of the issue. In reality, however, it may only be pursued if there are adequate assets available for recovery. This scenario must be checked if we are not to see a further contraction in ownership.
Unfortunately, we cannot afford to expect the legal profession to take the moral "high road", expose these cases for what they are, and summarily dispense with them for the protection of the industry. There remains a clear danger that for as long as the law operates on a contingency basis, it will not only be used to serve the ends of people who feel wronged and seek financial compensation as the remedy, but also for financial restitution or gain. If unchecked, the resulting effect will be to drive away those people who participate in the sport for their love of it.
As owners, we must accept that this industry carries no promises or warranties of either prosperity or satisfaction. Accidents will and do happen without there being any attributable blame. Everyone involved must be prepared to accept the responsibility of their participation and accept some of the extraneous risks that are involved in the sport of horseracing. We must continue to emphasize and remind everyone of the inherent risk of this industry.
Protections Available
Although the differences between the horse racing industry and other activities are unique and may, on reflection, seem onerous, the insurance protections available are similar in both content and character to any other pursuit. These differences should not alter the way one would protect oneself, but serve to reinforce the need to take at least diligent steps if not more.
Insurance cannot eliminate the risk, but fortunately it does offer some protection against the crippling cost of defending a suit. The horse industry has been an insurable class for some 50 years and provides coverages for all participants, including liability, property, mortality, workers compensation, and many other contingency coverages, unique to the industry. Racetracks also purchase huge general liability limits to protect themselves from a suit` which, as a publicly used utility, could come from any quarter.
Customarily, ordinary homeowners policies will exclude most equine activities. However, as an owner, general liability coverage specific to horse ownership is readily available and from a cost point of view, compares favorable with other pursuits with the premium being charged on the number of horses owned and their usage. Insurance companies providing such coverages, may be found through industry trade publications, or through recommendations provided by respected trainers or other owners. The TOC "Owner's Handbook" will also contain a list of broker/agents and insurance companies who provide equine-related insurance products.
Realistically, and in conclusion, we can only hope that people will act responsible, and that the insurance protections available will serve as prudent safeguards for their general protection.
Contrary to popular belief, the mere fact that an owner has transferred the care and protection of your horse(s) to another, be it a trainer or out to a farm, does not in the eyes of the law exonerate or remove you from blame and responsibility in the event that an incident were to occur.
Tax Audits, Avoiding Red Flags
Avoiding “Red Flags” that Trigger IRS Audits
By Herbert B. Wittenberg, CPA & Bruce A. Wittenberg, CPA
Tax time is just around the corner, so we asked the equine accountant team of Herb & Bruce Wittenberg to provide us with some tips for you on how to avoid creating “red flags” in your racing business that can trigger an IRS audit.
One of the most disagreeable events that can happen to your horse business is undergoing an audit by the Internal Revenue Service or state agency. Audits are time consuming as they require you or your accountant to round up your supporting data, and worse, can end up requiring you to pay more taxes. No fun!
The best way to avoid an audit is not to create “flags” that may alert the IRS that something’s amiss. Following are a couple of common “flags,” and ways to avoid creating them.
Red Flag:
Your Income Figures in Your Schedule C & 1099 Form Don’t Match
One common flag that often triggers an IRS response (either a letter from the agency, or the initiation of a full audit) is to have your racing stable’s gross income (purses, etc.), - shown on Schedule C of your tax returns - differ from the amounts shown on your 1099 Forms. It’s an easy error to make, as the net check amount you receive from the track’s paymaster is not the same as your gross income shown on your Form 1099, which is also generated by the track’s paymaster. This difference occurs because the track’s paymaster deducts various costs (such as jockey mount fees, box seats, photos, etc.) from your account, but reports your gross purse earnings to the IRS on the Form 1099. You can’t just add up your net check receipts from your paymaster’s account, you have to add back to it the track’s deductions to your income in order to have the Schedule C and Form 1099’s match. Of course, you then claim the deductions for mount fees, seats, and photos as business expenses.
Red Flag:
Only One Partner Receives a Form 1099 Showing All Partners’ Income
Another problem that can arise is when you’re involved in a racing partnership that has earned purse income. The track’s paymaster will issue a Form 1099 to only one of the partners, usually the one whose name is alphabetically first. So, if Adams, Baker, and Smith each own an interest in a horse, Adams will receive a “1099” showing the total purse income, while Baker and Smith will not receive a “1099.” Adams should report the total purse income (so his total “sales” agrees with all his “1099’s”), and then deduct (as a sales return) the portion he paid out to the other partners. Adams should then prepare Form 1099’s for his other partners who are receiving a portion of the purse income. You should also prepare Form 1099’s for anyone (other than a corporation) to whom you pay $600 or more for services rendered, and for which you take a business deduction. This would include your trainer, ranch, veterinarian, accountant, etc. The only exception to this rule is attorneys, whom you must send a Form 1099 even though they may be incorporated, and even if you paid them less than $600.
Failure to send IRS Form 1099’s can result in penalties of $100 per Form 1099 and/or disallowance of the expense.
Red Flag:
Failure to Report Wagering Income on W-2 G Form
Some owners are lucky enough to receive a W-2 G Form, which reports wagering income. If you are one of these owners, you should report your total wagering income, including the amounts shown on the W-2 G’s and the additional wagering income received for which you did not receive a W-2G. You should then claim a deduction for your wagering losses, which is claimed as an itemized deduction, and is allowable to the extent of the wagering income. It is a mistake (which can trigger an audit) to ignore the W-2 G under the theory that your wagering losses exceed your income. The IRS knows about the income, but they have no knowledge about the losses until you notify them by claiming them as a deduction. You should also save your losing tickets throughout the year since you might cash a big ticket at the end of the year. In addition, you should ask the pari-mutuel clerk to give you a receipt showing the cost of the winning ticket when you collect on a bet. It would be a poor practice to show only the W-2 G income, while having many losing tickets.
To summarize, make sure your racing stable’s income figures match on your Schedule C and 1099 Forms; report your wagering income and losses on a W-2 G form; and, if you’re involved in a partnership (and are the unlucky one who receives the 1099 Form from the track), make sure you deduct the income paid out to the other partners and send them a 1099 Form. Following these tips will help you avoid the dreaded IRS audit, and will help improve the profitability of your racing stable.
Preparing for an IRS Audit
By Herb Wittenberg, CPA & Bruce A. Wittenberg, CPA
These Tips Should Help You Win the Battle. Sometimes it just can’t be helped - the IRS notifies you that they’re going to audit your racing stable. Unfortunately, they’ve got their sights set on you,
so you scramble to collect your records and put your books in order.
Want to feel more prepared in the event of such a scenario? Then take a few minutes to read the following hints. They’ll help to avoid having the IRS decide against you, and will put your stable’s
books on firmer footing.
One of the more disagreeable events that can occur in your horse business is having to undergo an IRS audit. If you are unlucky enough to win the “audit lottery,” there are some problems that can be mitigated by planning ahead.
Note When You Acquired Your Horse for Depreciation Purposes
The IRS auditor will often ask for proof that you owned the horse that you’ve been depreciating and proof of its age at the time you acquired it. This is because two different “lives” are used to depreciate racehorses; a three-year and a seven-year cost recovery period. The three-year “life” is used if you acquired the horse as a two-year-old or older, while the seven-year “life” is used for horses acquired before they turned two, such as a yearling.
Remember, the IRS considers a two-year-old to be more than 730 days old - they do not use the universal racehorse birthday of January 1st for depreciation purposes.* Always retain a photocopy of your horse’s Jockey Club Certificate (its registration papers) even if you no longer own it. The papers show the horse’s date of birth, racing record, and the dates you had ownership of it. Retaining such documentation will prove to the IRS that you’ve been using the correct schedule to depreciate your horse. If you have disposed of the horse prior to the IRS audit and no longer have its registration papers, try to track down the horse’s current owner and obtain a photocopy of the certificate.
Consider Sales Tax Issues When Buying/Selling Horses Privately
When buying a horse from a private party, sales (or use) tax may be due. The sales tax is imposed on the seller if title to the horse passes in California. However, if you purchase a horse out-of-state and bring it into California within 90 days, California law imposes a use tax on the buyer. It’s exempt from the use tax if you bought the horse from an “occasional seller.” If the seller of the horse does not make two or more sales during a 365-day period, the sale qualifies as an “occasional sale” and no tax is due. If this is the case, you will want a letter from the seller indicating that he has not made more than two private sales in the last 12 months. Make sure to obtain a letter as part of the transaction, as your audit may be some 6-7 years down the road, and it is always difficult to obtain information at a later date. If you buy a horse overseas, instruct your bloodstock agent to obtain this letter from the seller.
Likewise, if you sell a horse privately and qualify as an occasional seller, no sales tax is due. However, if you don’t qualify as an occasional seller (you sell more than two horses a year), it’s up to
you to collect the sales tax and remit it to the State Board of Equalization. Note that selling two or more horses to the same party on the same day is counted as one sale.
If you are selling a horse to someone out-of-state or country, sales tax does not apply to the transaction. Therefore, in order to prove that the horse was sold outside of California, keep a copy of the vanning bill (even if you didn’t pay it) in order to prove that the horse was shipped out-of-state or country by a common carrier.
When determining a sale, exclude sales through auctions or claiming races. Giving away a horse doesn’t count as a sale either. Just be sure that you don’t accept the $1 consideration that the new owner may want to give you. If you do, then the transaction will be considered a sale. While the sales tax on a $1 is insignificant, the extra sales transaction might disqualify you from being considered
an occasional seller.
Keep Records to Prove Active Participation
The IRS sometimes questions whether you spend 500 hours or more a year overseeing your horse business. If you spend less than the required 500 hours per year, and if you have a net loss on your horse operations, the loss will be “suspended” as a “passive activity loss.” That means you can’t deduct your loss currently, but must accumulate your passive activity losses until such time as you can offset the losses with a “passive activity profit,” or cease being in the horse business. For example, assume you have accumulated $17,000 in suspended losses in prior years. You finally make a $10,000 profit. This $10,000 can be applied against the suspended losses, with the remaining $7,000 loss suspended to be written off against future years’ profits.
A better way to conduct your horse business is to keep a daily record of the time you and your spouse spend on your horse business so that you can prove to the IRS that you’re an active participant. This includes the time spent going to the track to watch workouts and races, time spent conferring with your trainer and/or bloodstock agent, trips to ranches, trips to racetracks when you are considering claiming a horse, time spent studying the Daily Racing Form, attending TOC seminars, and time spent paying your bills and keeping the books on your horse activity.
These time records should be kept contemporaneously to prove the 500-hour requirement, should you be audited. Keeping track of this time shouldn’t be time-consuming - the IRS will usually accept a simple log or journal.
How long should you keep these records? The State Board of Equalization can audit your records for the past 3 years if you have filed a sales tax return. If you haven’t filed a sales tax return, they can and do audit for the past 8 years. So, to be on the safe side, keep your racing stable’s records for at least the previous eight years.
While it isn’t fun to undergo an audit, following these hints should increase your chances of winning the dreaded IRS audit, and decrease your chances of being audited again. So get in the habit of keeping your stable’s books in good order so that you can minimize your headaches and maximize your fun in racing!
The father and son team of Herb & Bruce Wittenberg has offices located in West Covina, California. Their firm has been preparing tax returns for various racing stables since 1958.
* Note: Depreciation deductions on racehorses (or other personal property) is normally based on an assumption that any property placed into service during the year was in service for one-half of the tax year, regardless of when during the year the property was actually purchased and placed into service. However, different rules apply if 40% or more of all assets acquired during the year are acquired during the year’s fourth quarter.
IRS Hobby Loss Rules for Thoroughbred Racehorses
By Joost van Adelsberg, C.P.A.
In case you have not yet discovered, the IRS has a special place in its heart for the racehorse owner. That place is called the "Hobby Loss" Rule.
At the risk of stating the obvious, the operation of a racing or breeding stable is a risky business, which often results in a "loss" in any one particular year. The Hobby Loss Rules of Internal Revenue Code Section 183, deny the deduction of expenses in excess of gross income for certain activities the IRS determines are "not engaged in for profit." Those determinations are consistently litigated, creating a gold mine of litigation revenue for lawyers, and to some extent for accountants alike. How can an owner best protect oneself? The answer is a familiarity with the rules, and effective tax planning.
Horse Racing as a Business
While horse racing is a sport, it may nevertheless, for tax reporting purposes, constitute a "trade or business." The existence of a substantial financial risk in a racing or breeding operation should not necessarily characterize the activity as a "hobby" any more than it should in the case of other risky activities, such as mining, oil development, or securities trading. Clearly, all of these businesses involve a substantial risk factor and frequently lead to great loss, yet they are rarely deemed "hobbies" by the IRS.
Not Engaged In For Profit
The key to the Hobby Loss rule is the phrase "not engaged in for profit." Generally, in order to determine if an activity is not engaged in for profit the facts and circumstances of the particular operation must be examined. In order to make this determination easier, Congress created "safe harbor" rules that if met, will prevent the activity form being classified as a "hobby." Congress has established a special provision for the "breeding, training, showing, or racing of horses" which states that if the activity had net taxable income for 2 of the past 7 tax years, including the current year, the activity is presumed not to be a "hobby" and all losses may be currently deducted.
Didn't Meet the Safe Harbor Rule?
If a breeding or racing operation does not meet the safe harbor test, all is not lost. The activity may yet be deemed a "business" and entitled to all deductions. The burden of proving its status rests with the taxpayer however. The IRS is not going to take anyone's word for it; you must prove it!
Fortunately, the risky nature of horse-related activities is reflected in the more liberal profit presumption extended to such endeavors. As in the case of other risky activities, the key element in the test of whether a racing or breeding operation is "business" or a "hobby" is the owner's intention and expectation of profit. After all, substantial investment in valuable thoroughbred horses is arguably indicative of a good faith profit motive.
Treasury regulations provide nine factors the IRS must consider in determining if an activity is a hobby of legitimate business. Those factors are:
1. The manner in which the taxpayer carries on the activity;
2. The expertise of the taxpayer or his advisors;
3. The time and effort expended by the taxpayer in carrying on the activity;
4. The expectation that assets used in the activity may appreciate in value;
5. The success of the taxpayer in carrying on other similar or dissimilar activities;
6. The taxpayer's history of income or losses with respect to the activity;
7. The amount of occasional profits, if any, which are earned;
8. The financial status of the taxpayer; and
9. The elements of personal pleasure and recreation.
The taxpayer must remember that this list is not necessarily exhaustive and that other factors may weigh more heavily than others. For example, two factors the courts have frequently relied upon are: 1) the conduct of the activity in a businesslike manner, and 2) continuous losses.
Businesslike Manner
One factor, which will be scrutinized, is the manner in which the taxpayer carries on the breeding or racing operation. In the case where a stable is being actively managed by a person with experience, and who is prepared to abandon the enterprise or a component therein when it becomes obvious that the venture is definitely unsuccessful, the loss sustained will ordinarily be allowed. Likewise, a taxpayer is engaged in the breeding and racing of horses in a "businesslike manner" if he or she researches and plans horse purchases, advertises where appropriate, consults trainers or breeders, and becomes knowledgeable about the horse racing and breeding industry and its profitability
Continuous Losses
It has been held in a number of cases that the mere fact that the activity has shown continuous losses is not alone sufficient to establish that it is not operated for profit. In commenting on evidence of consistent "losses," one court pointed out the fact that even though the taxpayers were wealthy enough to afford a hazardous occupation, in which they found pleasure in spite of discouraging losses, the losses did not destroy the essential "business" nature of the occupation. In that case the taxpayers sufficiently established that the only reasonable measure of success, in their opinion, was financial gain.
The pursuit of "financial gain" can be a double-edged sword. In cases in which it is shown that the activity was originally engaged in for the purpose of making a profit, taxpayers may be denied deductions in subsequent years if the operation has shown a consistent loss. This disallowance is based on the assumption that a person would not continue in a business, which has consistently shown losses unless motivated primarily by the pleasure involved. Although the assumption is reasonable, isn't it also reasonable to assume that most taxpayers do not ordinarily indulge in extravagant "hobbies" involving substantial continuous losses? Obviously, there are additional factors, which will be considered in making the ultimate determination on permitted deductions.
In the case of horse racing and breeding activities, the standards by which ordinary business people determine whether a business is or is not a successful one are largely not applicable. In view of the character of the activity, an owner's earnings or losses generally fluctuate. To moderate such fluctuation requires considerable experience and skill. While profits and losses must be computed on an annual basis for tax purposes, this is not necessarily true in determining whether there was a bona fide profit motive.
Tax Planning
In California, a taxpayer's marginal tax rate can reach as high as 50.6%. This means the taxpayer is losing deductions that could otherwise reduce his or her taxes by 50.6% of all disallowed "hobby losses." For example, if a taxpayer had a $10,000 tax loss in one's stable activities for the year, and $200,000 dollars of other income, he could offset $10,000 of the $200,000 income with the stable activity losses. This would result in a tax savings of $5,060. However, if the IRS deems the stable activity a "hobby, " no deduction is allowed and the taxpayer's bill is $5,060 more.
Whatever the taxpayer's particular case is, early tax planning can mean the difference between the classification as a legitimate "business," and as a "hobby." The stakes are high. Be prepared.
Tax Implications on Selling Horses
Tax Implications of Selling Horses
By Joost van Adelsbert
When the time comes to sell a horse, the owner may be presented with many different means of closing the sale. Common Questions may arise, such as should one sell the horse for cash or trade the horse for another?
Regardless of which method an owner chooses, there can be some significant tax implications. This article will look at several methods of dealing with the tax implications and differing tax treatments.
Ordinary Income vs. Capital Gain
The breeder who sells weanlings or yearlings will always recognize ordinary income on the net proceeds from the sale and be taxed at his/her highest marginal rate. However, if the breeder waits until the horse is at least two years old, the net proceeds will qualify for capital gain treatment, and the owner will be taxed at the current maximum rate of 28%. The reason for the difference is that the holding period necessary to qualify the proceeds from the sale of a horse for long term capital gain treatment is a minimum of two years.
Inventory vs. Capital Asset
The same rules generally apply to owners of racehorses. Fortunately, there is one major difference. For the racehorse owner, the horse is considered an asset used in a trade or business and is depreciable. Just like any other business asset, when the horse is sold, the depreciation taken in the past must be recaptured and thus taxed at ordinary rates. For horses owned less that two years, the entire gain is taxed at ordinary rates. However, if the owner keeps the horse for longer than two years, only the portion that is required to be recaptured will be taxed at ordinary rates. The remainder will be taxed at the current, lower, more favorable capital gains rate.
The scenarios described above assume that the horse owner has made a profit on the sale. What happens if the horse is sold for a loss? Because the horse is considered a business asset, any loss incurred on the sale of the horse would be considered "ordinary." In that event, an owner can offset that loss against other income that is taxed at the owner's marginal rate.
"Like-Kind Exchange"
Another method available to the horse owner is to trade one horse for another in what is commonly known in the Tax Code as a "like-kind" exchange. As long as no cash or "boot" is involved, generally, no gain or loss will be recognized on the exchange by either party. The basis of the acquired horse will be transferred for the basis of the horse exchanged. Believe it or not, to be considered "like," the horses involved in the exchange must be of the same sex.
Horse owners should consider the various tax consequences of selling horses.
If cash or other items referred to as "boot" changes hands, then the owner receiving the boot will have taxable gain to the extent of the lesser of the cash received or the realized gain.
For example, "Bill" wishes to exchange his horse for "Jane's" horse. Bill's basis is $12,000, and Jane's is $10,000. Both agree that Bill's horse has a fair market value (FMV) of $14,000 and Jane's has a fair market value of $10,000. So, Jill agrees to give Bill $4,000 in cash.
Bill Receives
(FMV) of horse and cash) $14,000
Bill Gives
(Basis of horse) $12,000
Realized Gain $2,000
Cash Received $4,000
Gain Recognized
(Lesser of Gain or Cash) $2,000
If Bill owned his horse for more than two years, then the taxable gain in excess of the depreciation deductions previously taken will be taxed at the more favorable capital gains rate. Otherwise, the gain will be ordinary, and taxed at Bill's marginal tax rate.
Installment Sales
Another option available to the horse owner, albeit extremely rare in this industry, is installment reporting. Under this method, the seller agrees to finance the buyer's purchase by receiving payments from the buyer over time. For tax purposes, the seller may choose to either recognize the entire gain in the year of the sale or defer the gain and pay the tax as he/she receives payments from the buyer. Keep in mind that the two-year holding period and recapture provisions still apply as to gain characterization. If the sale results in a capital gain despite not receiving all the cash, recognizing the gain in the year of the sale may be advantageous if the seller has unused capital losses to offset the gain. On the other hoof, by paying the tax when the payments are received, the income may be taxed at a lower effective rates.
In conclusion, horse owners should consider the various tax consequences of selling horses. Because racehorses are considered property used in a trade or business, gains, if the two-year holding period has been met, receive favorable capital gains treatment. This may be even more advantageous in light of recent congressional budget proposals for a 50% deduction for net capital gains. The proposal obviously would result in lowering the top effective capital gains rate to 19.8%. Where a horse is sold for a loss, regardless of the holding period, the loss may be used to offset other income taxed to owners.
Naturally, before entering into any transactions, it is best to consult your tax professional.
Answers to Some “Taxing” Questions
April 15th is just around the corner, and TOC’s phones have been ringing with tax-related questions. To help you (and us), a helpful accountant with experience in the racing business has answered some of the most commonly asked questions.
By David Frith-Smith
I'm involved in a racing partnership that has recently purchased a yearling at the September sales. When is this horse considered placed "in service" for depreciation purposes?
In most instances, a horse is placed "in service" when it begins the activity for which it is purchased. In racing, this means either when it begins training (for racing stock) or when it arrives at the farm (for breeding stock). In most instances, yearlings are placed "in service" when they begin their "breaking and training", usually in the fall of their yearling year.
What should I do to prove that I "materially" participate in my horse business?
Proving that one :materially participates" in their horse business allows one to be considered an "active" participant and thus deduct losses incurred in the business against other forms of income, effectively reducing one's year-end taxability. Material participation occurs when the taxpayer participates in the activity in excess of 500 hours per year. This test can also be met if the taxpayer participates more than 100 hours per year, and this participation constitutes "substantially" all of the time necessary to conduct the activity. "Substantially" is defined as 75% of the time necessary to conduct the activity. Documentation should include writing records as evidence of your efforts, including bookkeeping; approving sales claims, or purchases; viewing workouts; meetings with trainers, jockeys, or breeders; time spent at the races, etc. Examples as evidence include daily logs and/or business calendars.
What is the capital gains holding period for racehorses?
Usually, the capital gains holding period for racehorses begins when the horse is purchased or born, and ends when it is sold. Gains from the sale of the racehorse qualify for a lower tax rate if held for the required period, which is two years for racehorses.
I purchased a weanling at the November breeding stock sales in Kentucky. and am curious to know if I have to pay California sales tax on the purchase?
State sales tax is imposed in the state in which the horse owner takes delivery. California will not impose sales or use tax if you do not ship the horse to the state during the first 90 days of ownership. In the event that the horse is moved to California during this 90-day period , sales tax can be avoided if the horse is moved outside of California for a majority of the first sic months after
purchase.
What is the Los Angeles County Tax on Racehorses?
California has adopted a special uniform tax code for racehorses, which is levied at a county level - the tax is imposed in the county in which the horse is located on January 1st. In Los Angeles, the tax is based upon the horse's earnings, and ranges from $20 - $150. The LA County Assessor's Office, which issues the "Annual Racehorse Tax Return" form can be reached at 213-974-2111 for direct answers.
David Frith-Smith is a certified public accountant and a partner at Frit-Smith & Archibald, LLP located in Tarzana, CA.
What Do You Do With A Passive Horse?
Passive Activity Loss Rules and Material Participation
By Joost van Adelsberg, CPA
What do you do with a passive horse? Sell it! (Rim shot, please...)
Seriously though, a general understanding of the complex IRS rules surrounding the concept of passive activity losses (PAL) is imperative for individuals wishing to invest money, time and energy in the Thoroughbred racing business. Most Thoroughbred owners do not want their horse racing activities characterized as a passive activity because of the limitations placed on the tax treatment of losses. As always, there are exceptions.
General Background
To gain a better understanding of the IRS's PAL rules, it is necessary to look back to the Tax Reform Act of 1986. A major impact of this act was the characterization of income into three different groups: active income; portfolio income; and passive income. Generally speaking, active income includes wages, salaries and income from a trade or business in which the taxpayer "materially participates." Portfolio income consists of interest, dividends or royalties payments. Passive income is income from any trade or business activity in which the taxpayer does not "materially participate."
These characterizations of income are important because the PAL rules only allow losses from passive activities to be offset against income from passive activities. If the losses exceed the income, then the excess losses become "suspended" to future tax years to reduce excess passive income, if any, from all passive activities of the taxpayer. In other words, these rules prevent the taxpayer from offsetting losses from a passive activity against the taxpayer's other active or portfolio income.
You may now ask yourself, "Why would anyone want to have their business treated as a passive activity, especially given that the typical racehorse venture often sees substantial losses for the first several years?"
Material Participation
There are two ways to structure businesses around the passive activity loss rules. The first is to meet the requirements of "material participation." "Participation" in an activity refers to any work that is performed on behalf of the business by someone who owns an interest in the business. "Material" refers to the extent of the work performed. Simply put, material participation is the extent that an individual is involved in the day-to-day operation of the business. To "materially participate" in a trade or business, the taxpayer must be able to answer yes to at least one of the following questions:
1) Did you spend more than 500 hours in the day-to-day operations of the business?
2) Did you substantially do all the work in the activity?
3) Did you spend at least 100 hours in the day-to-day operations, and was this more than anyone else's participation?
4) Did you spend between 100 and 500 hours in the day-to-day operations in two or more activities so that the total participation was more than 500 hours?
5) Did you materially participate in this activity for any 5 of the last 10 years?
6) If the activity deals with personal services, did you materially participate for any of the previous three years?
7) Do you have any other facts or circumstances which would indicate that you materially participate?
If you can answer "yes" to any of the seven questions above, then losses to which the activity relates will not be subject to the passive activity loss rules.
For the racehorse owner, the easiest questions to answer "yes" to would be questions 1 or 7. This would be true in most cases if the activity is held as a sole proprietorship as your business entity. Unless you are also the trainer, question 2 or 3 would be difficult to answer yes, due to the extensive participation of other individuals crucial to the enterprise. It becomes increasingly more difficult to answer "yes" to these questions if you are a general partner, a limited partner in a partnership or an S Corporation shareholder.
Alternatives
Other tax planning strategies one can consider to accommodate for the effects of the passive activity loss rules include selling or disposing of the activity that generates the passive losses, or investing in other passive activities which generate passive income.
In the case of dispositions, any excess losses suspended from prior years can be used to offset gains resulting from the sale for disposition of the activity. Previously suspended losses, which remain in excess of the disposition gain, can then be used to offset income from other passive activities. If losses remain after all passive income has been offset, then what is left can be used to offset other taxable income, regardless of its character. This planning strategy is most helpful in structured investments in partnerships of short duration that anticipate substantial losses during operations. A possible example would be investing in yearlings.
Investing in other passive activities, which generate income, is perhaps the least complex alternative for deriving current benefit from PALs. These Passive Income Generators, or "PIGs," can then sit at the PAL trough, so to speak, and eat up passive losses to the extent of income. While this strategy seems simple, it would require a crystal ball to gain any assurance that a PIG will only generate passive income instead of chewing a hole through your wallet!
Conclusion
As you can see, the Internal Revenue Service has once again given concise, simple, and easy to use rules to assist us in filing our tax returns! Seriously, in an attempt to increase tax revenue, the IRS has structured a method to accelerate the recognition of income by characterizing income into the three different groups and limiting the deductibility of certain losses of a group from the income of another group.
This article is meant to introduce some of the basic concepts behind the passive activities loss rules. An understanding of the basics of these rules will help you decide whether a particular investment is right for you with regard to the capital you invest, the time and expertise you are able to provide, and the tax implications of your decision. Of course, when applying these rules to everyday situations, they become increasingly more complex, so be sure to seek professional assistance whenever possible.
Joost van Adelsberg is a CPA with the accounting firm of Cooper & Lybrand in its San Diego office. Mr. van Adelsberg specializes in tax questions involving high net worth individuals.
Some Tips for Taxes - But Plan Now!
By Robert R. Hill, CPA
With the economy booming and the horse business healthy (just look at the recent record-setting Keeneland sales), there will undoubtedly be a lot of last-minute tax-planning by horse owners.
Unfortunately, last-minute tax planning is marginal at best, and quite often ineffectual. The better alternative is to do your tax planning as your fiscal year unfolds. With this in mind, here are a couple of tax saving tips:
“Deferred Exchange Agreement” Can Avoid Capital Gains Tax
A “Deferred Exchange Agreement” can be used in the sale of horses to avoid taxes on capital gains, as long as the horse sold is replaced by another horse or horses (up to four) of the same sex. This is a great idea when someone makes you “an offer you can’t refuse,” just accept the offer by entering into a deferred exchange agreement, which defers gains recognized on the sold horse. The timing of this agreement is a bit complex, and Uncle Sam’s regulations leave no room for error, so proceed with this agreement only with the help of a competent tax advisor or attorney, and an independent “qualified intermediary.” The “intermediary” holds the sale proceeds until a replacement horse has been found, and then remits the monies from the sale of the old horse to pay for part or all of the replacement horse(s).
The Internal Revenue Service requires that you “identify” your potential replacement horse(s) within 45 days of selling your horse, and close on the replacement horse within six months. Note that the “qualified intermediary” that holds your sale proceeds really has to be independent - it cannot be a relative, your attorney, your accountant, or your real estate agent.
The criteria for this transaction are very strict and should be followed explicitly. For example, let’s say someone offers you $100,000 for a racemare that you bred and raised*. You accept the offer by entering into a deferred exchange agreement with the buyer and the qualified intermediary. The intermediary holds your $100,000. Within 45 days of the sale you find and “identify” up to four potential replacement fillies and/or mares.
Within six months after the sale you actually take title to one or more of the animals by spending at least the entire intermediary’s $100,000. By properly completing this transaction, you have deferred the $100,000 gain on the sale of the original racemare. Accordingly, the above also works with stallions, stallion shares, showhorses, and breeding stock, but not horses held for resale.
First Year Tax Expensing
For those of you who procrastinate and only worry about your income tax situation after the end of the year, I can think of only one tax saving idea: First-year expensing. For 1999, IRC Section 179 allows taxpayers engaged in a trade or business to expense $19,000 of personal property, which would otherwise be depreciable.
Unfortunately, many tax practitioners are not cognizant of the fact that this first year expensing election also applies to horses. So, if you purchased some horses during the year, you may be able to use the first-year expensing election to reduce your income tax liability for the year. Remember that reduced income taxes require due diligence and planning, and that Uncle Sam is your partner, like it or not! Therefore, think about the ramifications of having such a partner, and plan your tax strategies accordingly.
*Depreciation and capital gains issues become more complex for horses that are purchased (as opposed to ones that are bred and raised) and then resold. To make sure your accounting is correct, consult with an accountant who is familiar with the horse business.
Robert R. Hill serves as the Director of Taxation at Crowe, Chizek, and Company LLP in Louisville, Kentucky. He has much experience in equine tax and accounting matters.
Reprinted with permission of the American Horse Council’s Tax Bulletin.
Form a Trust to Fund Your Stable
By Marc Pavlic
Yes, a trust does exist that is doubly advantageous to owners wishing to devote some of their hard-earned assets to their racing stables, while simultaneously receiving a tax deduction. Trusts can help you provide security for your family after death, avoid probate, make gifts to charity, and even create cash flow to help you pursue your passions, including the operation of your racing stable!
Yes, a trust does exist that is doubly advantageous to owners wishing to devote some of their hard-earned assets to their racing stables, while simultaneously receiving a tax deduction. Sound too good to be true? Are your ears pricked? Then carefully read on, as the charitable remainder trust can be used to keep your ponies in hay.
A charitable remainder trust is a legal arrangement that you can use to transfer assets, such as stocks, cash, or real property, to a beneficiary through an intermediary called a trustee. In exchange for the property, you receive over time a charitable tax deduction, plus an income stream paid to you annually that are generated by the gifted property. Usually the trust is structured so that you, and/or your spouse, receive income for life and your designated charity receives the trust assets tax-free upon your death.
For example, let's say Don and Mary have a total gross estate of $4 million dollars, and want to simultaneously decrease the size of their taxable estate while increasing the size of their racing stable. As part of their estate planning strategy, Don and Mary have been advised to remove assets from their taxable estate. Due to the monthly training and veterinary bills, they also have a need for present income. Knowing that under current law much of their estate can be lost to taxes and settlement costs if no estate planning measures are taken, their intent is to gift part of their estate to a charitable organization to take advantage of the benefits offered by a charitable remainder trust.
The couple decides to gift $500,000 of their estate to a charitable remainder trust, which will provide them with an immediate tax deduction (which can be deducted over five years), plus a stream of income for life or for a term not to exceed twenty years. When the trust terminates, its assets will be distributed to the charities that the couple designates.
Don and Mary are eager to start, as by doing so they'll immediate reduce their current tax liability, while at the same time generating a minimum of $25,000 annually that they can use to purchase racehorses or pay training bills. Depending upon the form of charitable remainder trust they choose, either a unitrust or annuity trust, the $25,000 will remain constant or will increase according to the gift's appreciation (or decrease according to its depreciation).
The unitrust form of charitable remainder trust will pay Don and
Mary a fixed annual percentage of not less than 5% nor more than 50% of the trust asset's value, based on an annual revaluation of the trust's assets. The annuity trust form will pay the couple a fixed annual amount throughout the term of the trust which cannot be less than 5% nor more than 50% of the initial fair market value of the trust's assets. This annual amount will not change as the trust's assets gain or lose value.
Either way, the Don and Mary can count on approximately $25,000, less income taxes, every year. And, if the couple wants a larger stream of annual income, they can increase the annual amount returned to them, although at least 10% of the original gift must remain in the trust.
However, decisions regarding the amount of income the trust will annually generate must be made at the trust's inception, and cannot later be changed. And while charitable remainder trusts are advantageous, they are governed by complex tax rules. A certified financial advisor should be consulted before establishing this or any other form of trust.
Just like Don and Mary, you too can set up a charitable remainder trust with part of your estate to enjoy tax savings and a steady stream of income to pursue your passion. Remember, the yearling
sales are just around the corner!
Marc Pavlick is a Financial Consultant with Merrill Lynch in Pasadena, California, and an aficionado of Thoroughbred racing.
Ground Transportation Pitfalls
By Scott Zimmermann
The squeamish should read no further, because what follows outlines one of the worst nightmares for a horse owner. Consider the following:
After years of bad luck and much money spent, a horse owner, let's call him "Turf Club Tony," finally is blessed with an exceptional runner, appropriately named Lucky. The purse monies for Lucky are rolling in, and it does not hurt that Tony is getting some pleasant recognition in the Daily Racing Form. Not only has Tony finally gotten lucky, but he also tries to take steps to protect his investment. Believing that he will be protecting his valuable asset, Tony substantially increases the mortality insurance on Lucky, particularly because the horse is now beginning to travel quite a bit in its racing campaign.
Tony bids Lucky bon voyage as the horse is loaded onto the horse transportation company's van to be taken to its next race. However, the next thing that happens is something no horse owner wants to hear. In the middle of the night, Tony receives a call from his trainer, "Back Stretch Bob," that Lucky has been seriously injured in an accident involving the horse transportation company van. Indeed, the injuries to Lucky are so serious that it is highly unlikely that the horse will race again, but Lucky will survive.
After making sure that Lucky is properly taken care of medically, Tony next turns his attention to trying to find out what his rights are. To that end, Tony contacts the horse transportation company. Tony is told the following:
1. The horse transportation company denies that it is liable for anything.
2. If the horse transportation company is liable at all, its liability is limited to a total of $2,000 the limitation of liability stated on the horse company's "bill of lading" that piece of paper that accompanies horses when they are being transported, usually signed by the horse's trainer or groom upon departure and upon arrival.
Tony argues with the horse transportation company, but cannot convince them that the accident was their fault. However, the assertion by the horse transportation company of a limitation of liability of $2,000 takes Tony by complete surprise. (To add insult to injury, Tony makes a claim on the horse's insurance policy, which is denied because the horse did not die, there being no loss of use coverage available in his policy or generally in the thoroughbred horse industry. Accordingly, if Tony cannot collect from the horse transportation company, he will have to bear the entire loss.)
Tony then asks his trainer Bob about the limitation of liability. Bob replies that he does not know about any limitation, but has heard around the backside that if a horse transporter is "negligent," it is responsible for the whole loss. Tony asks other trainers and owners and gets the same sort of reply.
What Tony is told by Bob and others is incorrect. The fact is that a limitation of liability contained in a horse transportation company's "bill of lading" is generally enforceable even if the horse transportation company is "negligent." The vast majority of owners and trainers do not know about limitations of liability, and the horse transportation companies certainly make no concerted effort to advise owners and trainers about limitation. Limitations of liability are usually buried in the fine print of the bill of lading and the horse transportation company's representatives do not usually, if ever, bring the limitations to the attention of owners and trainers. Indeed, many owners and trainers believe that a bill of lading is nothing more than a receipt that is to be signed upon the horse's departure and arrival.
The horse transportation companies would say in their defense that the rates they offer to the thoroughbred industry for transporting horses are reasonable because the rates would be considerably higher if there were no limitations.
While generally enforceable, there are various circumstances under which a limitation of liability will not be enforced. Accordingly, if you find yourself in the regrettable position of Tony, the thing you need to do is to contact a lawyer as soon as possible - and I do mean as soon as possible - because other provisions of a typical horse transportation company bill of lading allow an owner only nine months within which to make a claim, and only two years to file a lawsuit or be barred from ever collecting from the horse transportation company.
The next question is, naturally, what should an owner or trainer do on a day-to-day basis in dealings with horse transportation companies. One possible thing to do is to inquire about obtaining a higher limitation of liability than a horse transportation company must offer to its customers. However, I believe that the owner or trainer will find these rates to be uneconomical. Another thing that an owner or trainer could possibly do is to refuse to sign the bill of lading. However, the horse transportation company may refuse to ship the horse. In addition, from a legal point of view, it is far from clear whether a refusal to sign a bill of lading nullifies the limitation of liability contained therein.
However, one thing is clear - the way things presently operate needs to be changed. It is not fair for an owner of a horse to receive only $2,000 for the loss of a valuable race horse, nor should horse transportation companies be exposed to tremendous losses given the rates they currently charge.
The purpose of this article is to suggest that owners, trainers and horse transportation companies "sit down" with each other, and work out an equitable solution. Perhaps, what horse farms do could provide a useful example. Many horse farms secure "care, custody and control" insurance for the horses they board and spread the cost of the insurance among all of their customers. If such insurance is available in the horse transportation context, then the cost could be spread over all shipments, allowing horse transportation companies to forego limitations of liability or substantially increase the amount of their limitations.
I sincerely encourage owners and trainer to unite and work with the horse transportation companies to achieve mush needed change.