Danny Gargan - the trainer of 2024 Kentucky Derby contenders - Dornoch and Society Man

Article by Bill Heller

Hall of Fame trainer Nick Zito didn’t have a horse in either the Grade 1 Ashland Stakes at Keeneland April 5th nor the Grade 1 Blue Grass Stakes the following day. But he hoped for a personal daily double of those races with two of his protégés, Jorge Abreu and Danny Gargan, saddling a top contender in each race - Abreu with Jody’s Pride in the Ashland and Danny Gargan with Dornoch in the Blue Grass. 

Zito didn’t get what he wanted. Jody’s Pride ran out of gas in the Ashland and is getting a freshening before resuming her three-year-old campaign later this summer. Dornoch finished fourth in the Blue Grass and is now all systems go for a run in the Kentucky Derby.

Come the first Saturday in May, Danny Gargan will remember his first Kentucky Derby runner, Tax, who he claimed for $50,000 in his second career start in a maiden claimer at Keeneland on October 21st , 2018. Tax took Gargan to the 2019 Kentucky Derby, when he finished 15th, beaten 15 lengths at odds of 35-1.

Trainer Danny Gargan

Tax went on to win the Grade 2 Jim Dandy Stakes at Saratoga and the Grade 3 Harlan's Holiday Stakes at Gulfstream Park and in the process became Gargan’s highest-earning horse with $1,102,160. “He’s my favorite,” Gargan said.

Gargan did his homework to nab Tax, a son of Arch out of the Giant’s Causeway mare Toll. “I watched his video in his first race,” Gargan said. “He’s a really well-bred horse. He looked beautiful in the video. He sprinted that day. I was in New York, looking around for horses. He popped up in the entry box at Keeneland. I flew from New York to Kentucky to claim him.”

When he did, he called two of his owners, Randy Hill of R.A. Hill Stable and Dean Reeves of Reeves Thoroughbreds. “He called me up and asked me if I wanted in on Tax,” Hill said. “I said yes. Obviously, that worked out well. Danny’s one of my favorite guys, Danny’s a very good trainer. He’s finally gotten a chance to work with some good horses. He’s a terrific guy, he deserves this.”

Reeves said, “We had a lot of fun with that horse. It was a great run. Winning at Saratoga especially a big race up there.”

Gargan loved Tax: “He was a wonderful horse to be around, big and beautiful, just a kind soul in the barn. You loved seeing him there every day. He had a long career. He stepped into a grate and got his ankle caught. He missed more than a year.”

Tax came back off a 16 ½ month layoff to win a $100,000 stakes at Delaware on July 9th 2022, an outstanding feat by Gargan. “He was a pretty cool horse,” Gargan said.

Gargan has now trained three sons of Good Magic and all are now stakes horses. First up was Dubyuhnell who in 2022 Gargan thought might take him back to the 2023 Kentucky Derby after he captured the Grade 2 Remsen Stakes in his final start as a two-year-old. Instead, he finished 8th in the Grade 3 Sam F. Davis and 11th in the Grade 1 Florida Derby.

Now in 2024, Gargan has two sons of Good Magic in the Kentucky Derby. Dornoch, who finished fourth in the Grade 1 Blue Grass and Society Man, who finished second in the Grade 2 Wood Memorial at odds of 106-1.

Dornoch looks as talented as his full brother, Mage, who won the 2023 Run for the Roses. “They look opposite,” Gargan said.

“My horse is a real big bay. Mage is a medium chestnut. They don’t look the same, but they both have big hearts. You can’t breed that.”

Dornoch, was bred by Grandview Equine and sold for $325,000, $90,000 more than his full brother Mage, at the 2022 Keeneland September Yearling Sale. 

Last November Mage and Dornoch’s dam, Puca, went through the ring at Keeneland and was sold privately for $2.9m. This year, on April 4th, Puca produced her third colt by Good Magic who like his esteemed brothers all share an April birth date.

Dornoch’s name is intriguing, referring to the Royal Dornoch Golf Club in the Scottish Highlands where golf has been played for more than four centuries.

Born one year and four days after Mage was foaled, Dornoch spent his early days at historic Runnymede Farm in Paris, Kentucky.

For his early education, Dornoch was sent to Raul Reyes at King Equine in Ocala, Florida. Reyes detected that Dornoch wasn’t moving comfortably in his behind and discovered that one of Dornoch’s testicles hadn’t descended. The testacle was removed, and Dornoch showed vast improvement immediately.

Reyes called it a 360-degree turnaround in a story in Blood-Horse. Gargan thinks Dornoch will offer him a different experience if he makes it into the Derby starting gate. 

“Tax got us there. We were lucky enough to do the walk-over. This is different. This horse can win it. I’m happy to be a part of it. He reminds me of Louis Quatorze (the 1996 Preakness Stakes winner trained by Gargan’s former boss, Hall of Fame trainer Nick Zito). I’m hoping Dornoch can win a Triple Crown race. I’m preparing him the same way Nick did with Louis. Just keep moving forward. In horse racing, you have to hope you have a great day. In the past, we were just happy to be there. Now we have a horse that could win it.”

Zito, has been a fan of his protégé for a long time: “Danny was probably the best one I ever got along with. He read my mind. The guy actually read my mind, which I loved. He wants to win so bad. He communicates with horses so well. He said Dornoch resembles Louis. It shows his remembrance of great horses. That’s what I admire about Danny Gargan. Danny’s not taking a back seat to anybody at the Derby. He’ll have his horse ready to run.”

If Dornoch or Society Man win the Kentucky Derby, it will come 51 years after Gargan’s father, also named Danny, rode Bag of Tunes to win the 1973 Kentucky Oaks.

Unfortunately, Gargan, a native of Louisville, was just four when his father died. “I was so young, I don’t remember that,” Gargan said. “I grew up on the backside of Churchill Downs. I loved it from the start. It’s just something in your DNA.”

Asked how he got onto the Churchill Downs backstretch, Gargan said, “It was 30 years ago. Back then, they let everybody in.”

He worked for Nick Zito off-and-on for several years, eventually becoming his assistant. “Me and Nick are real good friends to this day,” Gargan said.

Gargan, though, came to a conclusion: “It takes a lot of money to be a horse trainer.”

So he switched careers, becoming a jockey agent. “I did it for a few years,” he said. His clients included Pat Valenzuela, Brian Hernandez Jr. and Jesús Castañón.

He called his jockey agent days “a lot of fun,” but he eventually became bored with it. He hooked up with owner Merrill Scherer on a few horses and, after two real good meets at Saratoga in 2011 and 2012, Gargan, decided to begin training on his own. He credits P.J. Campo, the racing secretary and then vice- president for racing of the New York Racing Association, for pushing him in that direction.

Gargan began a modest-sized stable in 2013, broke the $1 million mark in earnings in 2015 and has had at least $1.8 million in earnings every year since. “I race at Gulfstream Park and New York,” he said. “I don’t train a ton of horses, eight in New York and 22 in Florida. When you get so few young horses, it’s a blessing to have one,” he said. “It’s not every year. I’ve been lucky to have some nice horses in the past, and you have to be just thankful.”

Tax was not his only great claim.

On May 15th , 2017, Gargan claimed Divine Miss Grey for $16,000 for R.A. Hill and Corms Racing Stable off a three-quarter length victory as the 1-2 favorite.

Divine Miss Grey turned into a star for her new connections, finishing second in the 2018 Grade 1 Beldame at Belmont Park and capturing the Grade 2 Chilukki Stakes at Churchill Downs. She finished her career 12-for-26 with six seconds, one third and earnings of $934,172. “You get lucky sometimes,” Gargan said. “The good thing about what she did for me, was she brought me Dean Reeves and Randy Hill. They are the ones who probably brought me to train Dornoch. They wanted me to train younger horses. Without those two supporting me, I might have never made it to this point.”

Hill is one of many partners on Dornoch. Reeves is not.

When asked about his success, Gargan said, “I’m pretty lucky in that I trained for some good people, like Dean Reeves and Randy Hill. They want the horse put first. Always put the horse first. I’m blessed for having them. I don’t have to work the horse or race the horse. When you have owners that understand that stopping and doing the right thing for the horse is the most important thing, that’s great. That’s what’s changed for me the last four, five years is to be able to always put the horse first.”

He knows what he’s up against: “This game can be tough. You try to keep them happy, keep them healthy and keep them racing. It’s something we’ve always believed. With the young horse, it’s a tremendous factor. You watch other trainers and learn. Nick was a big fan of giving a horse his first race. Bill Mott does that, too. They don’t have to win first time out. They’re going to get better with racing. That’s our philosophy. Who knows if I’m right or wrong. That’s what we believe.”

Dornoch lost his maiden debut at Saratoga, too, finishing second. He finished second again, in the Sapling Stakes at Monmouth, before breaking his maiden at Keeneland and, just like Dubyuhnell, took the Remsen by a nose, defeating a potential Kentucky Derby rival, Sierra Leone. 

Racing on the lead on the rail, Dornoch set a pressured pace, opened a two-length lead in the stretch and then was confronted and passed by a fast-flying Sierra Leone. But Dornoch wasn’t done. He gamely fought back and re-took the lead just before the finish line. Like Gargan said, you can’t breed heart.

Winning his three-year-old debut in the Fountain of Youth pushed Dornoch to the front of many Derby contender lists. He was fourth to Sierra Leone in the Grade 1 Blue Grass, but he didn’t get his preferred trip pressing or making the pace. 

“We wanted to train him to sit behind horses,” Gargan said. “Sometimes, they have to experience things to get educated before they can improve. That was the first time he had dirt in his face and he fought it the first three-quarters of a mile.”

Dornoch is owned by West Paces Racing, Belmar Racing and Breeding, Two Eight Racing, Pine Racing Stables and R.A. Hill Stable. Gargan offered a piece to Reeves Thoroughbreds, but Reeves declined. “He asked me to buy into the horse,” Reeves said. “At the time, it just didn’t work. I passed. Too bad. I’m happy for those guys. I’m pulling for those guys. I hope he can get it done. He’s a great horse.”

Larry Connolly, who began West Paces Racing, mostly with his golf buddies in Atlanta in 2019, grew up in Rye, New York, and frequented Saratoga and Belmont Park. In 2012, Connolly sold his company, Connolly LLC, the largest global-recovery auditing firm, freeing up capital to buy Thoroughbreds. “It was a good time to jump in the deep part of the pool,” he said.

The final push into ownership came after five years of visiting Cheltenham races in England with his friend Lawrence Kenny, a retired steeplechase jockey. “After five years at Cheltenham, the racing was so good and the people were so nice,” Connolly said.

“We used to go to the pubs and see a lot of horsemen. I said, `Wouldn’t it be great if we could pool our resources together and get into a big race?’”

Connolly got involved with two partnerships, Donegal in 2014 and then Starlight. Connolly was able to enjoy the winner’s circle after Donegal’s Keen Ice upset Triple Crown Champion in the 2015 Travers Stakes at Saratoga.

Connolly said Royal Dornoch is his favorite golf course in Scotland. One of his partners on the horse is retired baseball star Jayson Wirth, an outfielder who played 15 seasons with the Blue Jays, Dodgers, Phillies, and Nationals.

Asked about Dornoch’s Derby pursuit, Connolly said, “It’s just super exciting. Every day is like Christmas Eve. What gets me excited about Dornoch is, he looks the part: size, grit, determination.”

West Paces Racing, Gargan and GMP Stables LLC are the owners of Society Man, who was stepping up to graded stakes company in the Wood off an impressive maiden victory. Three starts back, Society Man was eighth in the Grade 3 Withers. “He had a rough trip in the Withers,” Gargan said. “We’ve always liked him. He’s a nice horse.”

Gargan said Dornoch is bigger than Society Man, another son of Good Magic out of You Cheated by Colonel John. ‘They breeze together a lot,” Gargan said. “He worked with Dornoch for the Remsen.”

Asked about Society Man’s jump up in class in the Wood, Gargan said, “Sometimes you roll the dice and it works out. He’s improving at the right time and he can get the distance.”

Dornoch’s work tab was modest as he prepared for the Blue Grass Stakes on April 6th. “We just wanted to keep him healthy and sound,” Gargan said. “He’s a big colt. He can be playful. A little rambunctious. He’s not mean. He’s a big strong horse, just under 17 hands. He’s just under it.”

After his Fountain of Youth victory, Gargan told a TV interviewer that he guessed he had Dornoch at 85 percent for his three-year-old debut. The obvious goal is 100 percent on the first Saturday of May. “I don’t think we’ve seen the best from him,” Gargan said. “He’s going to be fun for a long time.”

Trainers vs. the IRS - qualifying losses as business deductions

By Peter J. Sacopulos

As a Thoroughbred trainer, you are running an equine-related business. But the IRS may decide you are merely enjoying an expensive hobby. If that happens, the agency will deny your business expense deductions and boost your tax bill. What guidelines should you follow to ensure that your activities are not miscategorized, and when is the law on your side?

Trainers vs. the IRS - qualifying losses as business deductionsthe IRS, equine activities and your tax bill By Peter J. Sacopulos  As a Thoroughbred trainer, you are running an equine-related business. But the IRS may decide you are merely enjoying an expensive hobby. If that happens, the agency will deny your business expense deductions and boost your tax bill. What guidelines should you follow to ensure that your activities are not miscategorized, and when is the law on your side? A costly questionHere is a riddle for you: When is a business not a business? Before you answer, I should tell you that the Internal Revenue Service (IRS) is asking, not me. And with that, as is often the case when a tax collector asks a question, the wrong answer could prove costly. So, when is a business not a business? When the IRS says it is a hobby. The question itself is valid. The United States Federal Tax Code taxes business income, among other things. In doing so, it allows any taxpayer who owns and runs a business to deduct all “ordinary and necessary expenses paid” during a tax year for “carrying on a trade or business.” However, the code also makes it clear that carrying on a trade or business means engaging in an activity to earn a profit, not because it is fun or enjoyable.  What does the IRS call engaging in an activity on a regular basis for the sheer pleasure of doing it? The same thing the rest of us do. “A hobby.”  Before Congress rewrote the federal tax code in 2018, some taxpayers might have been able to deduct certain hobby expenses. But they would have had to make money from the hobby, reported income and made sure their expenses qualified as miscellaneous itemized deductions under IRS rules. How many deductions does the current tax code allow for hobby-related expenses? Basically, none. From pleasure to profitMeanwhile, American popular culture bombards us with career advice, urging us to pursue our passion and follow our dreams. No wonder so many of us grow up fantasizing about wildly successful careers spent doing something we love. The budding guitarist dreams of becoming a rock star. The talented young artist, of selling paintings in Paris for millions. And the young man or woman with talent and skill for horses, of riding to victory in the Triple Crown. While dreams like these are longshots, they might come true. More realistically, they may lead to other careers. The grown-up guitarist teaches music lessons, for instance, while the artist works as a freelance children’s book illustrator, and the young horseman becomes a Thoroughbred trainer.  In each of these cases, the individual would be running a business that began as a hobby. Doing so might be their full time career, or a “side hustle” that supplements income from another job or business. These individuals may enjoy what they do a great deal. But once they start doing it to make money, their operating expenses are tax deductible. In other words, they are required to pay taxes only on their net profits (business income minus business expenses), not on the business’ gross profits (business income before the deduction of business expenses).  This means that items like the music teacher’s new amplifier, the illustrator’s new watercolor brushes and the trainer’s new tack may all be deducted, so long as the items are used for business purposes. The same applies to all other legitimate business expenses—from cellphones to facilities. And as the owner of any Thoroughbred-related business knows, expenses can add up quickly, especially when a business is starting up or expanding. The tax collector’s callUnfortunately, taxpayers sometimes believe they are running a business, only to have the IRS decide they are simply spending a lot of money on a hobby. When this happens, the IRS typically rejects the taxpayer’s deductions for business expenses and invokes any number of what the agency sees as remedies. These range from insisting that an individual pay higher taxes in a single year to auditing up to six years of tax returns and demanding the payment of additional back taxes, plus interest payments and monetary penalties. And woe unto the would-be wily tax cheat who clearly knows he is not really running a business and deliberately attempts to scam the IRS by claiming hobby costs as business expenses. Similarly honest mistakes on your taxes can be expensive. But in addition to being expensive, deliberate fraud can land the taxpayer in criminal court, and eventually prison. If the IRS deems a taxpayer’s activities a hobby instead of a business, and the taxpayer disagrees with the agency's determination, the taxpayer may gather their business records and other evidence and appeal to the IRS. If that fails, he or she may challenge the IRS in Tax Court. These situations can get complicated and expensive. Consider the landmark case of Merrill C. Roberts v. the Commissioner of Internal Revenue, in which a Thoroughbred operator challenged the IRS with dramatic results. Case in point Merrill Roberts is a successful entrepreneur who owns and operates businesses in the Indianapolis, Ind. area. Roberts proved skilled at making money in businesses in which turning a profit can be difficult, including restaurants and nightclubs. He had sold most of his businesses and largely relegated himself to consulting roles by the late 1990s, when he accepted an invitation to a Thoroughbred association dinner. A dinner created to draw new participants into the racing industry.  Merrill Roberts caught the horse racing bug, big time. Within a couple of years, he owned a dozen horses, including a breeding stallion. He stabled them on his own property and employed various trainers. He passed the test to become a licensed trainer himself in 2002. Roberts also joined industry associations, eventually accepting leadership positions in two such organizations. And he lobbied for slot machines at Indiana racetracks—the proceeds of which help increase racing purses. Immersed in his new activities, Roberts expanded his equine endeavors. He purchased 180 acres in rural Indiana and built an impressive new training facility. In addition to breeding, racing and boarding horses, Roberts grew hay on the property and leased some of the land to local farmers. His horses may not have set the world on fire, but his stable included some solid competitors. An expensive turn of eventsAlthough Merrill Roberts’ horse operations created significant gross revenue, his annual expenses were high. After making a small profit in his first year, he lost money for several more. The IRS audited Roberts’ tax returns for 2005–2008, and determined that during those tax years, his horse racing activities were a hobby and not a business. This meant that, for those years, the IRS refused to accept Roberts’ expenses for Thoroughbred activities as business deductions. Having dismissed his deductions, the IRS presented Roberts with a bill totaling over $1 million for back taxes, penalties and interest. But like many successful entrepreneurs, Merrill Roberts is no shrinking violet, and took the IRS to Tax Court. The case went to trial in 2014. In determining whether Roberts’ horse operations constituted a business under IRS rules, the Tax Court noted several points in his favor. First, Merrill Roberts conducted his activities in a businesslike manner. Second, he relied on solid accounting methods, including the services of certified public accountants (CPAs). Third, he invested large amounts of time in horse-related activities, routinely working eight-to-twelve-hour days. Fourth, Roberts relied upon industry experts, including respected trainers and bloodstock agents. Fifth, he also gained expertise himself, learning to be a trainer and passing a state licensing test that the Tax Court itself found “rigorous.” Sixth, he purchased property and invested in suitable facilities for the conduct of his equine activities; and seventh, Roberts reasonably believed his property would appreciate in value, adding credence to his claims of a profit-driven model. In addition to these factors, the Court noted that Merrill Roberts had a proven record of success in other business ventures. The Tax Court also noted that, although Roberts was wealthy, he did not appear to be so wealthy that he could view the funds spent on his horse operations dismissively. However, the Tax Court also noted that Roberts had received some income from real estate transactions and rental properties in certain years, which could have reduced the need for the horse operations to be profitable. And the court considered indications that Roberts enjoyed his Thoroughbred activities. Decisions, decisionsAt this point, you have probably decided that the IRS was clearly wrong about Merrill Roberts’ equine efforts, and the Tax Court quickly ruled in his favor. But remember, there is rarely an open-and-shut case. The Tax Court also recognized that in 2005 and 2006, Merrill Roberts attended races and on-track training sessions, indicating he enjoyed the social and recreational side of Thoroughbred activities. Even though, in 2007, Roberts had delegated those duties to an assistant trainer and spent more time at his own facilities.  The Tax Court ultimately ruled that, because Merrill Roberts received income from other business and because he enjoyed the social and recreational aspects of his horse operations, Roberts’ equine endeavors functioned as a hobby during the 2005 and 2006 tax years, but as a business during the 2007 and 2008 tax years. One could view this as a partial victory for Roberts, or a convoluted, illogical decision. Roberts saw it as the latter and took the case to the Seventh Circuit Court of Appeals. In April 2015, the Court of Appeals issued its decision. The ruling restated the many facts in Roberts’ favor as recognized by the Tax Court. It also noted that legitimate businesses could expect to lose money for a period of years due to start-up costs. It touched on the fact that horse racing is a business in which making a profit may prove difficult and pointed to Merrill Roberts’ various efforts to do so.  Appealing resultsThe Appeals Court then detailed the flaws and contradictions in the Tax Court’s ruling. It noted that the IRS had not challenged the business vs. hobby status of Roberts’ Thoroughbred activities during the years prior to 2005. This meant that, in the eyes of the IRS, Merrill Roberts’ equine activities had somehow transformed from businesses to hobbies and back to businesses in less than a decade. The Seventh Circuit judges found this absurd, especially since it eliminated start-up and expansion costs as business expenses. The appellate judges stated that a business-like activity could not be labeled a hobby simply because the owner had other businesses that produced a profit, regardless of how much the owner enjoyed the activity in question. Indeed, the concept of enjoyment was at the heart of the Court of Appeals decision. The Court of Appeals stated: “…obviously many businessmen derive pleasure, self-esteem, and other non monetary ‘goods’ from their businesses, and horse racing is just the kind of business that would generate such ‘goods’ for participants such as the owners and trainers (Roberts is both) of the horses….” The court dismissed the idea that enjoying aspects of an activity could be used to determine whether that activity was a business or hobby.  The Federal Court of Appeals held that it could not be too hard on the Tax Court for its convoluted decision, because the Tax Court had been required to follow regulations that were “goofy.”  The Federal Court of Appeals proceeded to deconstruct the IRS’ longstanding “enjoyment” standard. It pointed out that “fun doesn’t convert a business to a hobby”; “a hobby is not a career”; and that “a person deciding whether to take up a hobby is not contemplating a career change.” It added that “profit goes with businesses, not hobbies” and quoted a 1972 court decision that states: “suffering has never been made a prerequisite for deductibility.” Based on these factors and others, the court ruled in Merrill Roberts’ favor. His Thoroughbred business had always been a business. His deductions were allowed. He owed no additional taxes, penalties or interest for the years in question. It was a vindication that set new standards for the business/hobby determination. 9 things you must know So, how do you ensure the IRS regards your equine activities as a business and not a hobby? First, know that there are currently nine key factors the IRS expects you to consider before you report any activity as a business. Second, know that the agency uses these same nine factors to determine whether an activity is a business or a hobby. Third, know that the IRS may come to a determination by applying a single factor, all nine factors, or any combination of the factors to a particular situation.  Here are the nine factors the IRS currently uses, and expects you to use, when determining if an activity is a business or a hobby: 1.) Whether the activity is carried out in a businesslike manner and the taxpayer maintains complete and accurate books and records.2.) Whether the time and effort the taxpayer puts into the activity show they intend to make it profitable. 3.) Whether the taxpayer depends on income from the activity for their livelihood.4.) Whether any losses are due to circumstances beyond the taxpayer's control or are normal for the start-up phase of their type of business. 5.) Whether the taxpayer changes methods of operation to improve profitability.6.) Whether the taxpayer and their advisors have the knowledge needed to carry out the activity as a successful business.7.) Whether the taxpayer was successful in making a profit in similar activities in the past.8.) Whether the activity makes a profit in some years and how much profit it makes.9.) Whether the taxpayers can expect to make a future profit from the appreciation of the assets used in the activity. Details may varyThese nine factors are referred to as the “Facts and Circumstances Test.” If you have been in the business for several years, you may have noticed that some of these factors have changed since 2015, as a result, in part, of the Roberts case.  Some of the nine factors, including the number of profitable years within a certain timeframe, may vary based on the industry or type of business. Consider item number eight, regarding profitability over time. According to the IRS, activities should show a profit in at least two out of five consecutive tax years to be considered a business. But when “an activity consists in major part of the breeding, training, showing or racing of horses,” it should show a profit in at least two of seven consecutive tax years to be classified as a business and not a hobby. The longer timeframe is an acknowledgement of the challenges involved in making a profit in horse-related businesses. Be a pro, work with prosKnowing and following the “Facts and Circumstances Test” will help you stay out of trouble with the IRS. What’s more, this test will assist you in operating your business in a professional manner. These factors may even assist in expanding your business and increase your profits.  Many horse-related businesses are relatively complex from a tax standpoint. I recommend that a CPA and/or attorney with equine knowledge and experience be consulted. These professionals may also assist with decisions such as whether you should incorporate, and what type of business entity is best suited to your business model.  The IRS will continue to keep an eye on activities where professionals and hobbyists may overlap, particularly when those activities involve large expenses that might be reported as business deductions. 

A costly question

Here is a riddle for you: When is a business not a business? Before you answer, I should tell you that the Internal Revenue Service (IRS) is asking, not me. And with that, as is often the case when a tax collector asks a question, the wrong answer could prove costly. So, when is a business not a business? When the IRS says it is a hobby.

The question itself is valid. The United States Federal Tax Code taxes business income, among other things. In doing so, it allows any taxpayer who owns and runs a business to deduct all “ordinary and necessary expenses paid” during a tax year for “carrying on a trade or business.” However, the code also makes it clear that carrying on a trade or business means engaging in an activity to earn a profit, not because it is fun or enjoyable.

What does the IRS call engaging in an activity on a regular basis for the sheer pleasure of doing it? The same thing the rest of us do. “A hobby.” 

Before Congress rewrote the federal tax code in 2018, some taxpayers might have been able to deduct certain hobby expenses. But they would have had to make money from the hobby, reported income and made sure their expenses qualified as miscellaneous itemized deductions under IRS rules. How many deductions does the current tax code allow for hobby-related expenses? Basically, none.

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From pleasure to profit

Meanwhile, American popular culture bombards us with career advice, urging us to pursue our passion and follow our dreams. No wonder so many of us grow up fantasizing about wildly successful careers spent doing something we love. The budding guitarist dreams of becoming a rock star. The talented young artist, of selling paintings in Paris for millions. And the young man or woman with talent and skill for horses, of riding to victory in the Triple Crown. While dreams like these are longshots, they might come true. More realistically, they may lead to other careers. The grown-up guitarist teaches music lessons, for instance, while the artist works as a freelance children’s book illustrator, and the young horseman becomes a Thoroughbred trainer.

In each of these cases, the individual would be running a business that began as a hobby. Doing so might be their full time career, or a “side hustle” that supplements income from another job or business. These individuals may enjoy what they do a great deal. But once they start doing it to make money, their operating expenses are tax deductible. In other words, they are required to pay taxes only on their net profits (business income minus business expenses), not on the business’ gross profits (business income before the deduction of business expenses).

This means that items like the music teacher’s new amplifier, the illustrator’s new watercolor brushes and the trainer’s new tack may all be deducted, so long as the items are used for business purposes. The same applies to all other legitimate business expenses—from cellphones to facilities. And as the owner of any Thoroughbred-related business knows, expenses can add up quickly, especially when a business is starting up or expanding.

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