Business, or Hobby? Report Claiming IRS Has Been Delinquent in Reviewing Hobby Losses Issued

The Treasury Inspector General for Tax Administration has issued a report and found that the IRS has been delinquent in reviewing “hobby losses” on high-net-worth individuals who claim a Schedule C (or similar form) loss as a second business.  The report goes on to say that when tax returns containing potential hobby losses are selected for audit, the examiners do not always address the hobby loss issues.

The Treasury Inspector General evaluation of data from 2013 identified approximately 10,000 individuals who claimed a Schedule C loss of at least $20,000 with gross receipts under $20,000 and reported wages of at least $100,000. These same Schedule C businesses also reported losses in four consecutive years. Also, approximately 7,500 of these Schedule C businesses were found to be using “hobby” loss expenses inappropriately to reduce taxes by as much as $70 million for tax year 2013.

Section 183(a) of the Tax Code generally disallows business tax deductions for activities “not engaged in for profits” and Section 183(d), also referred to as the hobby loss provision, provides a presumption that most activities are engaged in for profit if the activity is profitable for three years of a consecutive five-year period (two years of seven consecutive years for breeding, training or racing of horses).

“Taxpayers with significant amounts of income from other sources may attempt to reduce their tax liability by including losses from activities not engaged in for profit” was the conclusion of the report. “The IRS needs to effectively identify these taxpayers in order to defer future non-compliance.”  Recommendations from the report were that the IRS should make use of research capabilities in the Small Business/Self-Employed Division to identify high-income individual returns with multiyear Schedule C losses and other factors that indicate the taxpayer may not have a profit or capital gain motive for the activity. 

The IRS has agreed with the recommendations and plans to take corrective actions. The IRS did disagree with the estimates provided in the report by saying that the IRS, not the taxpayer, bears the burden of proving that the taxpayer does not have a profit motives and therefore identifying returns with limited gross receipts, repetitive losses, and income from other sources is not sufficient to conclude that an activity was not engaged in for profit.

If you have a Schedule C or Schedule F business, please review the guidelines for Section 183 to determine if your activities are considered business or hobby and contact us with any questions regarding the schedulesVisit our Tax Services page to learn about other tax services that Schneider Downs offers.

You’ve heard our thoughts… We’d like to hear yours

The Schneider Downs Our Thoughts On blog exists to create a dialogue on issues that are important to organizations and individuals. While we enjoy sharing our ideas and insights, we’re especially interested in what you may have to say. If you have a question or a comment about this article – or any article from the Our Thoughts On blog – we hope you’ll share it with us. After all, a dialogue is an exchange of ideas, and we’d like to hear from you. Email us at [email protected].

Material discussed is meant for informational purposes only, and it is not to be construed as investment, tax, or legal advice. Please note that individual situations can vary. Therefore, this information should be relied upon when coordinated with individual professional advice.

© 2024 Schneider Downs. All rights-reserved. All content on this site is property of Schneider Downs unless otherwise noted and should not be used without written permission.

our thoughts on
Tax, Tax Policy BY Kirk Mitchell
Summary of President Biden’s 2025 Revenue Proposals Released in Treasury’s Greenbook
The Importance of Certified Business Valuation Professionals
Tax, Tax Impact BY Jared Sofranko
IRS Tax-Exempt and Governmental Entity New Compliance Programs
Tax BY Brianna Lundy
Employee Retention Credit: IRS’s Voluntary Disclosure Program Expiring on March 22, 2024
Pillar Two is Here; Is Your Company Ready?
Not-for-Profit, Tax BY Sarah Piot
Not-For-Profit Tax Credit Opportunities Included in the Inflation Reduction Act
Register to receive our weekly newsletter with our most recent columns and insights.
Have a question? Ask us!

We’d love to hear from you. Drop us a note, and we’ll respond to you as quickly as possible.

Ask us
contact us
Pittsburgh

This site uses cookies to ensure that we give you the best user experience. Cookies assist in navigation, analyzing traffic and in our marketing efforts as described in our Privacy Policy.

×