Taxing Lessons From Court Decisions

Decisions — On the wild side

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Movies, books, the great outdoors — sometimes even the tax code takes a walk on the wild side. Here are two recent decisions to test your knowledge about tax rules less-traveled.

Deer farming

In a determination letter,  the IRS responded to a request from an association of deer farmers for tax exempt status.

The association’s stated purpose is to protect members from losses from a disease affecting deer herds. Only breeding farms are covered. As members experience deer losses, the membership as a whole is solicited to provide funds to partially reimburse the member for their losses, based on the value of their herd per an appraisal utilizing genetics and production records. A percentage of the final appraised value would be available to a member. The herd owner would absorb the remaining loss.

The association’s regulations advise members to sell the infected herd to the governing agent and collect indemnity if possible. If that amount is less than the appraised value, the herd owner is eligible to collect the rest from the association’s plan.

No collections would be made from the membership until a disease positive herd or trace outs are disposed of. The date used to determine payouts would always be the date that a deer is found to be positive. There would be no coverage for any member not signed in at least 45 days prior to a positive test.

Here’s the relevant tax law.

From internal revenue code section 501(c)(5): Provides for the exemption from federal income tax of labor, agricultural, or horticultural organizations.

From section 1.501(c)(5)-1(a) of federal income tax regulations: States that organizations described under code section 501(c)(5) are those which have no net earnings inuring to the benefit of any member, and have as their objects the betterment of the conditions of persons engaged in the pursuits of labor, agriculture, or horticulture, the improvement of the grade of their products, and the development of a higher degree of efficiency in their respective occupations.
 

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THE DECISION

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Arrowheads

In legal advice notice to program managers PMTA-2017-04, the IRS provided a legal opinion on the taxation of replacement fishing spools and broadhead replacement blades.

The questions were:

(1) Is a replacement fishing spool subject to the tax imposed by section 4161(a)(4)? (A fishing spool is part of a fishing reel.)
 
(2) Is a broadhead replacement blade subject to the tax imposed by section 4161(b)(1)(B)(ii)? (A broadhead is an arrowhead with three blades.)
 
The IRS arrived at the same answer to both questions. Here’s the relevant tax law.
 
From internal revenue code section 4161(a)(1): Imposes a 10% tax on the sale price of any article of sport fishing equipment.
 
From internal revenue code section 4161(a)(4): Treats an article of sport fishing equipment as including any parts or accessories sold on or in connection with the sport fishing equipment.
 
From internal revenue code section 4162(a)(2): Provides that a fishing reel is an article of “sport fishing equipment.”
 
From section 48.4161(a)-2(c) of the Manufacturers and Retailers Excise Taxes Regulations: Defines “fishing reels” as including all mechanical and electrical devices that contain a spool for dispensing and recovering fishing line, and are designed for use with fishing rods in casting and in reeling in hooked fish in the sport of fishing.
 
From internal revenue code section 4161(b)(1)(B)(ii): Imposes an 11% tax on the sale price of a broadhead that is used with an arrow described in section 4161(b)(2). An arrow described in section 4161(b)(2) is an arrow, which after its assembly: (1) measures 18 inches overall or more in length; or (2) measures less than 18 inches overall but is suitable for use with a bow that has a peak draw weight of 30 pounds or more.
 

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THE DECISION

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 Note: Taxing Lessons provides a summarized version of sometimes lengthy decisions. The full notice may include facts and issues not presented here. Please use the link provided in the post to read the entire notice.
 
This information should not be considered legal, investment, or tax advice. Taxing Lessons and Top Drawer Ink Corp. do not provide legal, investment, or tax advice. Always consult your legal, investment, and/or tax advisor regarding your personal situation.

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Sorry, wrong answer :(
Right answer!

Do not grant tax exempt status.

You do not meet the qualifications under section 1.501(c)(5)-1 of the income tax regulations because your activities are not aimed at the overall betterment of conditions within the farming industry. You operate to aid your members in mitigating losses. You work with other members to insure losses on member herds. Where members would otherwise have to insure themselves, you are relieving them of this responsibility by providing this service.

Providing insurance services to members does not serve an exempt purpose under section 1.501(c)(5)-1 of the regulations because your activities are not aimed at the overall betterment of conditions within the farming industry generally. Instead, you specifically benefit your individual members.

By providing an insurance service, you are not bettering the conditions of those engaged in agricultural pursuits, improving the grade of their products or developing a higher degree of efficiency in their operations. Your principal purpose is to provide a direct business service for your members.

Insuring member herds is a business service which operates for the benefit of members. This service relieves your members of having to maintain their own insurance. Such activity does not serve an exempt purpose under section 1.501(c)(5)-1 of the regulations.

We concluded you are not operating as an organization described in section 501(c)(5) of the code. Your operations are not aimed at the overall betterment of conditions, improvement of the grade of products, or the development of a higher degree of efficiency with the farming industry, but provide a direct business service for the benefit of your members.

Therefore, we have determined that you do not qualify for exemption under section 501(c)(5) of the code.

Sorry, wrong answer :(
Right answer!

Neither are subject to application of the manufacturers excise tax imposed by section 4161 of the internal revenue code.

(1) A fishing spool is not an article of sport fishing equipment identified in section 4162(a), but it is part of a fishing reel. See section 48.4161(a)-2(c). When a fishing spool is sold on or in connection with a fishing reel, the fishing spool is taxed as part of the fishing reel. See section 4161(a)(4). When a fishing spool is sold as a replacement fishing spool separate from a fishing reel, the replacement fishing spool is not sold on or in connection with a fishing reel. Therefore, the tax imposed by section 4161(a) does not apply to a replacement fishing spool that is not sold on or in connection with a fishing reel.

(2) A broadhead is an arrowhead with three blades. Webster’s Third New International Dictionary (3rd edition). A replacement blade is only one component of a broadhead and not a broadhead itself. Therefore, the tax imposed by section 4161(b)(1)(B)(ii) on a broadhead does not apply to a replacement blade for a broadhead.

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