Prevailing On Business vs. Hobby Determinations Is Now More Important Than Ever

Recently, Joel Crouch wrote an excellent blog (link) about a taxpayer who prevailed over the IRS, which had argued that the taxpayer’s ranching business was not really a business. While it is great that the taxpayer was victorious, had the Tax Court determined that the ranching operation was not a business, but a hobby, the taxpayer may have still been entitled to claim some deductions for its hobby expenses. This is, in part, because the years at issue in that case (linked here) were 2015, 2016, and 2017. The legal landscape is much less friendly for recent years.

Prior to 2018, it was generally understood that taxpayers were able to claim hobby expense amounts at least up to the amount of hobby income. There was also generally understood to be an additional limitation that mandated that such a deduction be reported as a miscellaneous itemized deduction (and thus only expenses exceeding 2% of a taxpayer’s adjusted gross income could be deducted). While certainly not as beneficial as getting to deduct the full amount of expenses incurred as business expenses, it was something. For 2018 through 2025, Congress suspended the deductibility of all miscellaneous itemized deductions.  As a result,  taxpayers are, according to the likely IRS view, unable to deduct any hobby expenses (and still have to pay taxes on all of the gross income). (There may be flaws in the likely IRS view, but that is beyond the scope of this writing.)  Given these stakes, there may be good reason to reconsider whether an activity that was previously reported as a hobby activity should have in fact been treated as a business. If so, perhaps a refund claim may be appropriate if the underlying facts support that the activity should have been reported as a business.

Whether a particular activity is a hobby or a bona fide business is generally a highly-fact specific determination. In this author’s experience, the IRS regularly—at least initially—presumes activities with recurring losses are not actual business endeavors. Now, with the IRS auditing tax returns for years after 2017, the stakes are higher to demonstrate to the IRS (or a court, where necessary) that the underlying activity is a business activity. Ultimately, the underlying issue boils down to whether the taxpayer intended to turn a profit for the activity, but there are a multitude of factors that are analyzed to arrive at the conclusion. Making that case is more important than ever.

If you have any question about this article or any tax matter, please email me at jglassman@meadowscollier.com or call me at 214-749-2417.