Sunday, August 21, 2011

Tax Treatment of Racing Crashes

At 7 am on the morning of May 30, 1941, George Barringer was putting gas into his car in a garage northwest of Indianapolis. It wasn’t just any car; the number 35 was painted on it. And it wasn’t just any garage; it was part of a complex of garages called “Gasoline Alley” at the Indianapolis Motor Speedway. Barringer’s car had qualified at 122.299 mph.

At the same moment, in the next garage last-minute preparations were also taking place. The Thorne Engineering crew was working on its entry, number 5, to be driven by Joel Thorne. Part of the final preparations included a bit of spot welding.

Gasoline fumes from Barringer’s garage drifted over into Thorne’s area and ignited. The resulting fire destroyed a number of wooden garages in Gasoline Alley. Fire officials, racing crews and others were pulling cars, equipment, fuel drums and anything else they could from the flames.

Viewing the remains of George Barrington's racer, May 1941. From left: Deacon Litz, George Barrington, Wilbur Shaw. Photo courtesy of IMS Photo Operations

What would be the tax effects if such an event occurred today? Before we answer that, we should get acquainted with some tax lingo – specifically the term “casualty.”

A “casualty” is defined as the damage or destruction of property due an identifiable event. This event must be sudden, unexpected or unusual.[1] Unless an event that results in damage or destruction of property meets this definition of a “casualty,” no deduction is normally allowed.

“Sudden” means swift and not gradual or progressive. The classic example of gradual damage is termite damage to a structure. From a racer’s standpoint, normal engine wear would probably be classified as gradual and not a casualty.

An “unexpected” event is ordinarily unanticipated or unintended.

An “unusual” event is one that’s not considered to be a day-to-day occurrence. It’s not typical of the activity in which you’re engaged.

Assuming your loss fits the definition of a “casualty,” the next step is to consider whether the property was owned by a corporation or individually. The ownership factor makes a great deal of difference in the tax treatment of casualty losses.

A casualty loss sustained by corporation is treated as a “sale of property.” If a corporation owns a racecar (or any other business asset) that’s damaged or destroyed, and the event qualifies as a “casualty loss,” then the adjusted basis of the item (cost less accumulated tax depreciation) is compared with the sales price of the asset after the loss. If the sales price is larger than the net book value, you normally have a taxable gain; if less, then a taxable loss results. If there’s no insurance recovery or the asset is scrapped, then the sale price is zero and a taxable loss can result.

The tax treatment is entirely different for property owned by an individual.

There’s a special rule for individually owned racecars damaged or destroyed in competition: there is no deductible loss because there’s no “casualty.” In a 1982 private letter ruling[2], the IRS stated, “in automobile races, crashes and collisions involving the participants’ automobiles are common. Such events are neither extraordinary nor nonrecurring…Without regard to whether the loss resulted from an event that was sudden and unexpected, the loss did not result from an event that was unusual.” Bottom line: you can’t get a casualty loss deduction for an individually owned racecar involved in a crash during a race.

If the asset is not an individually owned racecar damaged or destroyed in competition, individually owned property can be divided into two categories:

Business property, which includes property held for the production of income, and
Personal use property.

If business property is completely destroyed as a result of a casualty loss, the individual owning the property will follow the same rules as a corporation mentioned above.

However, if the business property owed by an individual is only partially destroyed due to a casualty loss, the loss is the lesser of the following items:

The adjusted basis of the property, or
The difference between the fair market value before and immediately after the casualty loss. In many cases, the cost of repairs is a good measure of this difference.

Any insurance recovery reduces the casualty loss, regardless of whether the property being owned by an individual or corporation. In some taxes (incredible as it may seem) a taxable gain could result from a casualty loss when insurance recovery is figured into the computations.

The distinction between business use property and personal use property for individuals also depends on the hobby loss rules, which were mentioned in earlier blogs. If there’s no profit motive in your racing activity, the individually owned racing equipment that suffered a casualty loss will probably be considered personal use property.

To compute the casualty loss on personal use assets, you would use the same rules as for computing the partially casualty loss on business use assets, There’s a limitation on casualty losses for personal use assets.The loss is only deductible if:

You itemize your deductions,
The loss is greater than 10% of your Adjusted Gross Income, and
You must subtract $100 from each loss prior to deduction.

Going back to the 1941 race, if today’s tax rules had been in effect and assuming George Barringer owned his car personally and his racing were considered an “activity for profit,” the destroyed race car would have qualified as a casualty loss of a business asset, since it wasn’t involved in a race at the time of the fire. However, if there were no fire and his car would have been raced that Memorial Day of 1941, any damage sustained during the race would be ineligible for a casualty loss deduction.

Interesting footnotes: Only 31 cars started in the 1941 Indy 500. George Barringer was awarded 32^nd place in the final race results and received $530 for his efforts. His car was the only one of the 33 entries that was damaged or destroyed in the fire. Sam Hanks, who would eventually win the 1957 race, was awarded the 33^rd spot in the 1941 race. Hanks didn’t even start the 500; his car was damaged in a practice session the day before. Joel Thorne’s car started the 1941 Indy 500 in the 23^rd position and crashed on the fifth lap in the first turn. He placed 31^st and was awarded $535.

Wilbur Shaw led for 107 laps but had an accident on lap 151 due to a blown tire. Days earlier, he was examining the tires he would use during the race. The tires he felt least comfortable with were marked “Use Last” in chalk. However, the water used by the fire department to extinguish the garage fire washed off his chalk instructions written on the tires. As a result, the less desirable tires were randomly placed with the others in his pit box prior to the start of the race.

Stuff happens…

Drop me an email at phil.schurrer.racingprof@gmail.com if you or your group would be interested in a detailed presentation about this topic or other tax and financial aspects of motor sports. I'd also be interested in any comments you have about the blog or suggestions for future topics

Until next time …

Phil Schurrer, CPA

“This posting is intended to provide general information regarding the subject matter covered. It is provided with the understanding that the author is not engaged in rendering legal, accounting, or other professional services. This information should not be used as a substitute for professional advice in specific situations. If legal advice or other expert assistance is required, the services of a professional should be sought.”
- Adopted from a Declaration of Principles jointly adopted by a Committee of the American Bar Association and a Committee of Publishers.

Attorneys and other professionals dealing with specific matters and situations should also research original sources of authority.

[1] Rev. Rul. 72-592 1972-2 C.B. 101

[2] Ltr. Rul. 8227010

Wednesday, August 3, 2011

Valuation of Collector Cars - Lessons from the Dodge Daytona #71

In the past, I’ve commented about the importance of a well-documented valuation for donated collector cars. So now let’s turn our attention to probably one of the most famous stock cars ever to run on the NASCAR circuit – and the lessons to be learned from its valuation.

Introducing the Dodge Daytona # 71 - - -

Use of this photo courtesy of legendarycollectorcars.com

A little background about #71. It's a 1969 Dodge Charger Daytona with a 426 CID hemi engine. In 1969, Bobby Isaac, together with crew chief Harry Hyde (both NASCAR legends), won 17 out of 40 races with #71. In 1970 the feat was repeated, along with winning the Grand National championship (the forerunner of today’s Sprint Cup Series) and setting a world record of 199.653 mph for a stock car on a qualifying lap. #71 also held the record for the fastest lap around a closed course of 201.104 mph. After 1971 it also set several land speed records at the Bonneville Salt Flats in Utah.

There’s an interesting story associated with the life and times of this legendary racecar. And – yes – part of if involves a Tax Court case[1] that centered on the valuation of #71 when it was donated to the National Motor Sports Hall of Fame in 1977.

In 1957 Nord Krauskopf organized the K & K Insurance Agency, Inc. Its primary purpose was to sell auto racing insurance. Krauskopf had a background both as an insurance agent and a racing driver.

K & K became very successful, due in part that there were only two other firms engaged in selling this type of insurance at that time. One of K & K’s major accounts was the IHRA, and K & K insured over 700 tracks across the country.

In 1966 K & K began acquiring stock cars and started to compete on NASCAR’s Grand National Circuit. Initially, K & K competed in only 11 races each year, but by 1970, they were involved in 30 to 40 races annually. K & K hired a crew chief, racing crew (including mechanics and pitmen), and acquired a truck and trailer for transport purposes. Chrysler, Goodyear, STP, Monroe Shocks, Union 76, and Perfect Circle Piston Rings were some of the major sponsors who contributed both parts and money to K & Ks racing campaign. K & K also received money from toy companies that manufactured and sold kits for constructing a model of #71.

K & K became quite successful in stock car racing. Goodyear alone paid K & K between $40,000 and $120,000 for advertising. K & K placed in the top ten in points in seven of the ten years in which it was involved with racing. In 1970 K & K stood atop the leader board in points by virtue of #71’s performance.

In 1971 NASCAR changed the rules. It limited the size of the engines to 305 CID and mandated the use of a restrictor plate for large engines. So, after 1971, rather than selling the car to teams that were less successful or who raced in smaller, less prestigious circuits, K & K decided to keep # 71 because of its speed records and, perhaps, for sentimental reasons. In 1972 the car was not raced, but instead exhibited around the country on a “farewell tour.” After the tour, the car was partially dismantled and ultimately came to rest in an open, fenced lot behind K & K’s garage.

In 1973 K & K, together with its racing business and assets, merged with another insurance agency and Krauskopf received 50 percent ownership in the new company.

In June 1976, Krauskopf entered into an agreement with his partner to transfer all the racing assets from K & K to a new company, except for #71 (transferred to Krauskopf personally) and another car (transferred to Krauskopf’s partner.)

By this time, #71 was badly rusted, partially due to the salt from the Bonneville Salt Flats. The front fenders, trunk deck, and hood had been removed and the vehicle had been exposed to the weather for several years.

In the fall of 1977, the National Motor Sports Hall of Fame, near Talladega, Alabama contacted Krauskopf about contributing #71 as its first exhibition racecar. Krauskopf agreed and contacted Robert Gee about restoring #71. Gee had worked as a mechanic on #71 during the “glory” years of 1969 to 1971 when #71 was setting all its records. The restoration to original racing condition cost about $10,000 (How times have changed!) and in December 1977 Krauskopf donated #71 to the Hall of Fame.

At this point, the “tax tango” begins. Krauskopf took a charitable deduction for the car because the Hall of Fame is an organization qualified under the tax code to receive charitable contributions. (The donor receives a deduction on his or her tax return.) Krauskopf attached an appraisal by the curator of the Museum of Speed in Daytona Beach to his 1977 tax return, which stated that the value of #71 was $165,000. Krauskopf took a deduction of half that amount ($82,500) because the car was a long-term capital asset and, had it been sold, half of the value would have been taxable.

The IRS audited Krauskopf’s 1977 tax return. One of the main audit points was the deduction of $82,500, the value of #71 listed as a charitable deduction on the return.

Some background at this point would be helpful. The tax code allows a deduction for the “fair market value” of an item donated to an organization approved by the IRS to receive charitable contributions. Both the IRS and Krauskopf agreed that the Hall of Fame was such an organization. The big point of disagreement was the fair market value of #71.

The definition of “fair market value” for tax purposes is “the price at which the property would change hands between a willing buyer and a willing seller, neither being under any compulsion to buy or sell and both having a reasonable knowledge of relevant facts.”

The IRS contended that the value of #71 at the time of the donation was $35,000, which is the total of $25,000 (#71’s value when received by Krauskopf personally in June 1976), plus the $10,000 in restoration costs.

At the trial, the Museum of Speed’s curator did not testify, so the Tax Court did not consider his appraisal. But, testimony of M.H. Gould, better known as “Tiny” Gould, was given. In Gould’s opinion, the value of the car was $25,000 when it was distributed to Krauskopf by K & K in June 1976, and $150,000 when it was donated to the Hall of Fame in December 1977.

The IRS objected to Gould’s testimony because: he seemed to lack familiarity with #71; he would have found it difficult to find a buyer for the property; and he had never taken any formal courses in appraising.

Fortunately for Krauskopf, the Tax Court allowed Gould’s testimony. The Court noted that Mr. Gould was a former stock car driver and had a lot of experience in buying and selling collector cars. Over a twenty-seven year period, Gould had dealt with 30 to 35 racecars. He was a judge at numerous car shows and belonged to a number of car clubs as well as NASCAR. Based on the above, the court accepted Gould as a qualified appraiser.

Gould did not personally inspect #71, but studied photos of it and was aware of its records and background. He was also aware that the car was placed in a museum and would be viewed by at least 250,000 people annually, as opposed to being sold to an individual collector. It went on a nationwide tour and was given extensive radio and television coverage. Mr. Gould testified that the car had undergone a ground-up restoration and that he knew of no car that was comparable.

The Tax Court decided that the value of #71 for tax purposes was $100,000. We’ll never know why they chose a middle value between Gould’s assessment of $150,000 and the IRS’ valuation of $35,000. What we do understand, however, is the thought process the Tax Court used and the guidelines they employed in valuation of items such as racecars. These are the important lessons for motor sport fans from this case.

First, merely because there is a limited market for the property (in this case, #71) doesn’t mean it can’t be valued.
Second, merely because the property is unique doesn’t mean it can’t be valued.
Third, all relevant facts and circumstances need to be considered in the valuation process.
Fourth, the use of the property (in this case, exhibition at a museum) needs to be considered when valuing the property.

(We can only wonder why Krauskopf didn’t use the testimony of the curator of the Museum of Speed, the individual whose assessment letter of $165,000 was attached to Krauskopf’s tax return. Certainly two witnesses for the taxpayer would not have harmed Krauskopf’s case, even if their values were not identical.)

The lessons for any car collector or donor are clear. The competence and background of the appraiser is of great importance. In addition, the four principles of valuation mentioned above are valid and useful for anyone facing the challenge of determining the “fair market value” of collector cars – or anything else.

The fate of #71? Today it resides, restored to its former glory, at the Wellborn Muscle Car Museum in Alexander City, Alabama.

(My thanks to Richard Fleener of legendarycollectorcars.com for his assistance. Visit his website; I know you’ll find it interesting and informative.)

Until next time …

Phil Schurrer, CPA

- Adopted from a Declaration of Principles jointly adopted by a Committee of the American Bar Association and a Committee of Publishers.

Attorneys and other professionals dealing with specific matters and situations should also research original sources of authority.

[1] Krauskopf, T.C. Memo 1984-386, 48 TCM 620

Saturday, July 23, 2011

Depreciation of Collectible Cars

In 1971 the IRS audited Harrah’s Club of Reno, a casino that operated hotels and gambling casinos. To attract patrons, Harrah’s maintained a museum of about 1,000 antique automobiles. It was successful; over 200,000 people visited the museum in that year.

The casino purchased and restored these antique cars, acquired in various stages of deterioration. The museum itself was housed in a 10-acre complex, and included display areas, restoration workshops and an extensive research library. Over 150 people were employed in the museum and restoration areas.

The Tax Court arguably gave the best description of Harrah’s restoration process:

“The…restorations involve extensive showroom-or-better quality replacements and additions of body, engine, upholstery, lights and paint. Each restoration is preceded by historical research into the specifications of the original vehicle. Restoration is then carried out with meticulous attention to every detail…at great cost. Upholstery and paint are reproduced as they were originally. Entire portions of the body and engine, down to individual engine parts, are renewed, to the extent of making castings from borrowed samples of parts whose replacements cannot be found…(Their) restorations have such an excellent reputation for quality that they add a premium value to the…restored vehicle.”

The tax case[1] involved the proper tax treatment of restoration costs for 94 vehicles. Harrah maintained that these costs should be deductible in the year they were incurred.

The IRS opposed that position, and stated that the restoration costs were capital in nature because they would benefit more than one year. The government relied on a tax regulation that stated that normal repair costs can be deductible as an expense, but those costs that either added to the value or prolonged the life of the asset (the antique cars) were not deductible, but should be capitalized and added to the original cost of the asset.

In response, Harrah stated that if the restoration costs were to be added to a capital account, then they should be depreciated over a period of five to ten years.

The ball was in the IRS’s court. The government then played their ace: depreciation can only occur if the cars had a useful life that could be reasonably estimated. The cars, once restored, could last indefinitely. They pointed out that antique cars were held and displayed in the Smithsonian Museum for decades with no deterioration. Bottom line: no depreciation deduction.

Harrah then played its final card. They responded that, since many of the cars had a market value greater than a normally restored vehicle (due to Harrah’s first-class restoration techniques), the difference between the market value and the costs of restoration plus the initial cost should be deductible or depreciated.

An example of Harrah’s position might help. Recently, I saw a 1985 Firebird for sale for $1,500. The engine needed work and there was some rust on the body. If I paid the $1,500 for it, and decided to restore it to “showroom condition” and display it, I would need to spend, say $10,000. At this point, I would have $11,500 in the ‘Bird.

But maybe the market value is only $9,000, even for one in prime condition. Using Harrah’s initial logic, I’d want to deduct the $10,000 in restoration costs. IRS says no; it has to be capitalized. I now have an $11,500 asset, and the next best option for me from a tax standpoint is try and depreciate the $11,500.

Again, IRS says no, because the car now has an indefinite life. So, my last attempt to get some tax benefits from this deal is to try and depreciate the $2,500, the difference between the total costs expended ($11,500) and the market value ($9,000).

IRS again says no. The excess of the initial price and restoration costs over the market value of the car can’t be depreciated. The $2,500 is part of the $10,000 in restoration costs and can’t be separated.

Bottom line: Harrah’s Casino was unable to get any tax benefits from the restoration costs until the vehicles were sold.

Those who collect and restore cars can probably expect the same tax treatment. Recommendation: save all restoration documentation and sort it for each vehicle. It will be needed to figure the tax gain or loss when the car is finally sold. It appears that the year of sale will be the only time when tax benefits – if any – will be available for car collectors.

Footnote: Bill Harrah died in 1978 and Holiday Inn purchased the remaining shares of stock in the casino. Included in that purchase was the vehicle museum, which then had about 1,400 vehicles in its collection. Holiday Inn auctioned off the majority of the collection for about $100 million net. A small portion of that collection now forms the basis of the National Automobile Museum in Reno.

Let me know if you or your group would be interested in a presentation going into these topics or other tax and financial aspects of motor sports. I'd be interested in hearing from you.

Contact me at:

phil.schurrer.racingprof@gmail.com

Until next time …

Phil Schurrer, CPA

[1] Harrah’s Club v. U.S., US Ct. Claims, 554-77, 9/23/81

Tuesday, July 12, 2011

Tax Aspects of Car Collecting and Restoration

From the beginning this blog has focused on the tax problems faced by race team owners or drivers. Now let’s turn the spotlight and look at on the potential tax problems of those who collect and restore automobiles.

The rules about hobby losses still apply. The nine rules mentioned earlier are still valid for both collectors and restorers. Bottom line: the collector/restorer has to document the existence of a profit motive if he or she hopes to deduct any expenses over and above the amount of revenue earned. And there’s usually very little revenue in car collecting or restoration until the car is sold. (And that involves another set of tax rules, which we’ll review in a future blog.)

Profit Motive Illustrations for Collectors and Restorers

As we’ve seen, the experiences of others who have battled the IRS in court are helpful and provide us with some idea of what – and what not – to do. This is called the “case method” of learning, and it’s used extensively in law schools and graduate business programs. It teaches lessons from the problems of real people in real-life situations. We can learn a great deal from the experiences of others. Racecar drivers talk with other drivers, and team owners share experiences.

There are three tax cases that directly relate to car restorers and collectors.

The first deals with a 1978 Tax Court case involving Richard and Evelyn Smith of Xenia, Ohio.[1] On their1973 tax return, they claimed $4,720 in deductions for repairs and restoration costs relating to a 1957 Ford Thunderbird that they had purchased for $500. The car was sold in January 1977 for $4,500. Upon audit, they were assessed $1,663 because the IRS disallowed the repair costs.

At trial, the taxpayer claimed two reasons for purchasing and restoring the T-Bird: investment, and the pursuit of a hobby. He further claimed that the expenses were made in order to make a profit. (If it’s a hobby, it doesn’t have a profit motive. You can’t have it both ways.) The IRS claimed that the expenses were not made with the expectation of profit. Furthermore, they claimed that the expenses were capital in nature and not deductible.

Although the taxpayer claimed a profit motive, he admitted that he knew nothing about car restoration and personally did very little work on the T-Bird. The court ruled that Smith offered no proof (other than his own testimony) about the existence of a profit motive. The court noted that over five years had passed between the purchase of the car and its sale. They reasoned that a profit-motivated owner would have sold it earlier. Smith offered no evidence of any unsuccessful attempts to sell the car.

Bottom line: if you’re going to claim a profit motive for car restoration, be able to document your expertise, your sales attempts, research done about car prices for a particular make and model before you purchase – in short, everything a professional restorer with a goal of making a profit would do.

(Incidentally, Smith represented himself at trail. Presumably, an attorney would have made sure that he never uttered the word “hobby” in court.)

The second tax case involves the 1993 Tax Court decision regarding Lynn Crawford, a Dallas physician.[2] Dr. Crawford received his medical degree in 1978, and began an auto restoration business in 1982. He located it in Louisiana on his parent’s property, which was a three- to five-hour trip from his house. He would work on cars over weekends and occasionally hire others to help him. On his tax returns for 1983 through 1986, he claimed losses of nearly $40,000, of which approximately $21,000 consisted of depreciation. His only records were spiral notebooks, and the entries in them were generally not made at the time the transactions took place.

The Tax Court applied the nine factors associated with the hobby loss rules and ruled that Dr. Crawford came up short. He had no backup for any of the expenses, kept no record of the cars being restored (nor were the car titles in his name), kept no budget, took depreciation on inventory (a no-no), and couldn’t explain why his restoration business was located so far away from his residence.

There were a number of other issues in this case, but for motorsport participants the lessons are clear: a profit motive must be documented.

The third case, involving Floyd and Dorothy Garrett [3] of Florida, can shed some light on the problem of using the wrong bank account to pay for cars added to a collection.

Floyd owned two trucking companies and used the bank accounts from these businesses to purchase additions to his muscle car collection, which he began in the mid-1970’s. At one time, he owned 35 cars. He had hoped to start a museum to house his collection.

In January 1989, he sold 25 cars for $1,200,000. On that year’s tax return, he claimed a cost of $800,000 for the cars and his return showed a taxable profit of $400,000 on the sale.

The Garrett’s returns for 1989,1990 and 1991 were audited. During these years, approximately $624,000 was paid out of his two corporations relating to his muscle car collection.

Floyd faced two big problems:

First, he never purchased the cars with his own personal funds, although the cars were titled in his name. Therefore, he couldn’t claim the cost of the 25 cars sold because he didn’t personally pay for them. Also, he couldn’t document how he arrived at the $800,000 amount. Result: the entire $1,200,000 was subject to tax.
Second, since his businesses didn’t own the cars, they couldn’t claim any expenses relating to them. Result: all expenses were disallowed.

It may seem as though the IRS was splitting hairs, but the lesson is clear: make sure all your i’s are dotted and t’s are crossed.

The Garrett’s also had the usual hobby loss problems. He admitted that the car collection was a hobby prior to the 1989 sale and couldn’t show a profit motive for the car collection. No bank statements, cancelled checks or corporate records were provided. The court found Floyd’s testimony “vague, confused, self-serving and uncorroborated.” (Ouch.) The case came to trial in 1997 and a museum building was in the final stages of completion, but no museum had been established. This also was a factor in the court’s finding of a lack of a profit motive.

Summary

The hobby loss rules apply. Review the nine factors used by the IRS.
Document, document, document. And the time to do it is when the transaction takes place and details are fresh. Don’t begin the collection of paperwork the day you get the IRS audit notice. Memories fade, paperwork gets lost (or tossed), and the consequences can be expensive.
Make sure you get professional help. Some of these rules can be tricky. You wouldn’t trust an engine rebuild to just anyone; the same holds true with other aspects of motor sports, including the business or financial end of it. (Of course, if you can claim your racing, collecting or restoring as a hobby, your life becomes simple. Just include all income on your tax return and don’t deduct any expenses.)

In the future, we’ll continue our look at the tax aspects of car collecting and restoring, and focus on valuation questions, depreciation and capital expenditures.

Let me know if you or your group would be interested in a presentation going into these topics or other tax and financial aspects of motor sports. I'd be interested in hearing from you.

Contact me at:

phil.schurrer.racingprof@gmail.com

Until next time …

Phil Schurrer, CPA

[1] Smith, 37 TCM 325

[2] Crawford, 65 TCM 2540

[3] Garrett, 73 TCM 2799

Monday, July 4, 2011

Numbers – and A Note of Thanks

On this Independence Day, I’ve found myself with a little spare time and thought I take a look at the statistics for this blog. (I don’t track my own page views.)

I was amazed to discover that the blog had been viewed 170 times since it first began on 12 March of this year. I don’t have any experience or background to determine if this is the norm with other blogs in the initial phase of existence, but I’m truly pleased, especially since it's directed at a rather narrow topic.

The viewing has been steady and it seems to have attracted somewhat of a worldwide audience. So, being an accounting and tax professor, I felt compelled to share some numbers with you:

Month # views

March	40
April	38
May	36
June	39
July – to date	17

Country # views

United States	146
Germany	9
Zimbabwe	6
Argentina	2
Brazil	2
United Kingdom	2
Canada	1
Philippines	1
Singapore	1

I’d like to thank everyone who has taken the time to look at the blog. Hopefully you’ve found something both interesting and valuable.

One thing I’ve noticed is the lack of comments, either at the bottom of the blog, or posted on the contact URL that I insert in the blog itself. I’d appreciate any comments (positive or negative), suggestions for future topics, questions, or inquiries about my speaking to your group or organization about the tax and financial aspects of motor sports.

Once again, thanks for your viewing, and I look forward to your comments.

Contact me at:

phil.schurrer.racingprof@gmail.com

Best regards,

Phil Schurrer, CPA

Friday, July 1, 2011

Understanding Motorsports’ Financial Statements

Every racer and team manager or owner quickly realizes the importance of money in a racing organization. Budgets, cash flow, and endorsement income rank right up there with elapsed times, lap speeds, RPM’s, chassis adjustments and horsepower.

This blog is designed to give you some insights into the reading of financial statements – that collection of numbers that your accountant or bookkeeper periodically gives you, with the expectation that you’ll understand their significance.

One of the difficulties of being a racing team manager owner is that many financial concerns ultimately come down to one or two questions, such as: ”How much is this going to cost?” and “Do we have enough cash for the next race?”

There are a few motorsports companies, such as Speedway Motorsports, Inc., or International Speedway Corporation, whose financial information in easily available. That’s because they’re public companies and their stock is bought and sold on stock exchanges. These companies are registered with the U.S. Securities and Exchange Commission, and by law anyone can look at their financial statements.

If you were to look up the numbers for any publicly held company, you’d soon be buried under an avalanche of numbers and footnotes. It’s not unusual for a publicly held company’s report to exceed 75 pages.

But, you’re a manager or owner of a small racing team and you’d like to get the most useful information in the least amount of time, hopefully, the following information will help.

For our purposes, there are three basic financial statements:

· The income statement, also known as the profit and loss sheet.

· The balance sheet, and

· The statement of cash flows.

Each of these statements focuses on a different financial aspect of the business operation and they’re integrated. The ending balance of one statement influences another, just as the pressure of a brake pedal is transmitted through the fluid in the brake lines to the brake caliper. Both the financial statements and the brakes form a complete system. Every component is essential.

Let’s take a look at each financial statement in some detail.

The Income Statement is the first statement prepared. It shows the profit or loss at the end of a time period. It does this by listing all the items of revenue and then subtracting from that total all the expenses. If the result if positive, the business has a profit. If it’s negative, the business has suffered a loss for that time period.

Some things to remember about the Income Statement:

· Not all money that comes into a business is revenue. If a business raises money through a sale of stock or a bank loan, the income statement isn’t affected.

· The profit amount will be the stepping-stone for determining the income taxes of a firm. There are adjustments to be made to convert that profit number to taxable income. This is a special area for accountants.

· Profit is not the same as cash. An increase is profit doesn’t always equal an increase in cash. It’s very possible for the cash balance to increase (say, through a loan) and the profit to decrease (because of the interest expense associated with the loan).

· Income statements cover a period of time – a month, quarter or a year.

The Balance Sheet is a listing of what the business owns (Assets), what it owes (Debts or Liabilities), and what’s left over (Equity). Putting it another way, if a business – any business – were to liquidate and sell all the assets, convert everything to cash, and pay off all debts, any amount left would go to the owner(s). The total amount of assets must always equal the amount of liabilities plus the equity amount.

Some additional items about a Balance Sheet include:

· Balance sheets are prepared as of a specific date, usually year-end or the end of a quarter or month.

· Assets include cash, accounts receivable (what others owe the business), prepaid rent and insurance, equipment (such as the equipment covered in a previous blog on depreciation), and inventory. (Unless a racing team purchases items for resale, it’s doubtful that there’s much if any inventory.)

· Liabilities are debts owed to other firms, such as for supplies, parts, taxes, payroll, and advertising – the list goes on and on as you well know.

· Equity is the owner’s financial interest is in the business. Any profit for the year is added to equity; any loss is subtracted from it. This is an example of the integrated nature of financial statements mentioned earlier.

· A well prepared Balance Sheet separates the assets and liabilities each into “current assets” and “current liabilities.” Current assets are cash and those items that will be converted into cash or used up in a year. Current liabilities are those debts that will be paid within a year. This distinction is important and has everything to do with “working capital.”

· Working capital is the result of subtracting current liabilities from current assets. If the result is positive, then the business can be viewed as being able to pay its bills on time. If the result is negative, the conclusion is the opposite and is a warning sign.

The Cash Flow Statement is a “diary” of cash ins and outs – inflows and outflows – organized into three categories or “activities.”

· Operating activities – the day-to-day operations of the business. For racing teams, this has everything to do with placing a car and driver in a race.

· Financing activities – the raising or money through sale of stock or borrowings. The three ways a business raises money are through profits, through sale of stock, or through loans. The last two items each have good and bad features; profits are always good. (Larger profits are even better.) You should also know that selling of stock of your racing team to anyone who’ll buy it may be illegal. You absolutely need to consult with an attorney on this.

· Investing activities – the spending of money on fixed assets, such as equipment, dynos, cars, etc. In this context, “investing” does not mean the buying of stocks and bonds with excess funds. (Frankly, for most racing activities, “excess funds” are non-existent.)

· The ending balance on the cash flow statement must equal the ending balance of cash on the balance sheet. (Another example of financial statement integration.)

A major focus of a Cash Flow statement is the amount of funds generated through operating activities: prizes, endorsements, contingencies, etc. If a business continually funds its operations through financing activities, that business has a difficult future.

Two absolutely vital financial characteristics of a business that need to be kept in mind at all times are profitability and solvency.

· Profitability – the ability of a business to consistently make a profit. By doing this, the survivability and long-run prosperity and success of the business are greatly increased. The key indicating number reflecting this is the profit or “net income” amount on the Income Statement.

· Solvency – the ability of a business to pay its bills. The prime indicators for this are the working capital numbers mentioned above and the analysis of the cash flow statement.

Profitability and solvency are not the same. It’s very possible for some businesses to have large amounts of profit in the beginning of their existence, but insufficient cash. Both are needed. A racing team needs to establish a pattern of profits to insure its survival and keep it solvent so it can pay its bills.

When I talk with my students or clients, I always mentioned “Schurrer’s Laws of Business Survival”

· There’s no such thing as excess profits, provided they were arrived at honestly

· The game is over when the money runs out.

· You can do many things with cash and no debt

· May your taxes double next year. This means that your net income (profit) will have risen by the same factor, all things being equal.

Profitability and solvency (as well as many other factors) can be determined by property understanding and using financial statements.

Remember, no one every bought a quarter-inch drill bit because he wanted a quarter-inch drill bit. He wanted a quarter inch hole. Financial statements, like drill bits, are tools. Use them well.

Let me know if you or your group would be interested in a presentation going into these topics or other tax and financial aspects of motor sports. I'd be interested in hearing from you.

Contact me at:

phil.schurrer.racingprof@gmail.com

Until next time …

Phil Schurrer, CPA

“This posting is intended to provide general information regarding the subject matter covered. It is provided with the understanding that the author is not engaged in rendering legal, accounting, or other professional services. This information should not be used as a substitute for professional advice in specific situations. If legal advice or other expert assistance is required, the services of a professional should be sought.”
- Adopted from a Declaration of Principles jointly adopted by a Committee of the American Bar Association and a Committee of Publishers.

Attorneys and other professionals dealing with specific matters and situations should also research original sources of authority.