It would appear that the IRS has been allowing executives and other high-wage earners to offset their taxes by losses from their hobby activities. At least, that was the conclusion of a recent report by the Treasury Inspector General, which has oversight responsibility over the IRS. The Treasury Inspector identified a sample of returns with the following attributes: (i) wages of $100,000 or more; (ii) Schedule C receipts of $20,000 or less; (iii) net business losses of ($20,000) or more; and (iv) four consecutive years of losses. The Treasury Inspector critically observed that only 4% of those returns had been selected for audit by the IRS and not necessarily for hobby-loss reasons. Further, based on its review of the sampled returns, the Treasury Inspector estimated that over 88% of the returns showed an indication of a business not for profit. The Treasury Inspector recommended that the IRS modify its audit detection techniques to flag high-income returns with multi-year Schedule C losses. The Treasury Inspector also recommended that the IRS increase hobby-loss compliance checks in SB/SE audits to ferret out potential abuses. The IRS agreed with both recommendations and agreed to implement corrective measures by March 2017. For a full copy of the Treasury Inspector’s report, follow this link: https://www.treasury.gov/tigta/auditreports/2016reports/201630031fr.pdf.
The takeaway is that IRS scrutiny is coming for wage-earners with multi-year Schedule C losses. The time is now to visit with your at-risk clients about the nature of their Schedule C businesses and to help them bolster and document the for-profit nature of such businesses so as to better fend off a future challenge by the IRS. If you have any questions regarding the Treasury Inspector report or ways to help your clients enhance the bonafides of their part-time businesses, please do not hesitate to contact Anthony Daddino at (214)749-2464.