When Can the IRS Call Your Business a Hobby?

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Under the hobby loss rules you can’t deduct expenses in excess of income, so no loss is allowed.  A Shutterstock_158874281
recent tax court case (Akey, TC Memo 2014-211) involved a collector of sports memorabilia who also was a full-time quality assurance engineer.  On his tax returns he claimed substantial losses, including two years in which he showed zero income, zero costs of goods sold, and approximately $20,000 in other expenses.

The taxpayer failed to insure the collectables, maintain a bank account, had no inventory system, and did not keep accounting records.  At the trial the taxpayer testified that he had an honest objective of turning a profit and that he had learned to grade the condition of sports cards as a means of enhancing his expertise.

The tax court uses the following nine factors to determine if the activity is a business or a hobby:

  1. The manner in which the taxpayer carries on the activity.
  2. The expertise of the taxpayer or his or her 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, earned by the taxpayer.
  8. The financial status of the taxpayer.
  9. Any elements of personal pleasure or recreation.

Based on its analysis of these factors, the tax court ruled with the IRS and disallowed the losses as non-deductible hobby losses.

When in doubt, check with your tax advisor.