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HOBBY LOSSES DOG IRS AUDITOR

August 28, 2008

We were chatting about hobby losses recently. Yesterday we get a new case where a taxpayer got in trouble under the "hobby loss" rules of Section 183. This wasn't just any taxpayer; it was an IRS auditor.

Section 183 says you can't take business losses if you aren't really trying to make money. The Tax Court says the auditor's conduct made it look like he wasn't in it for the money:

Petitioner did not carry on his greyhound activity in a businesslike manner. He did not maintain complete and accurate books and records regarding his greyhound activity, did not maintain a written business plan, and did not contemporaneously prepare budgets or financial analyses for his greyhound activity. Although petitioner claims to have prepared a "cost analysis plan", at trial he acknowledged that this plan was prepared only in the course of the audit and examination of the tax years at issue. His substantiation of claimed expenses was spotty and consisted largely of some canceled checks supported by his vague testimony. He had no written contracts with the third parties who trained, hauled, and raced his greyhounds

The first sentence is the key: he didn't run his "business" in a "businesslike manner." If they way you go about an activity makes it look like you aren't even trying, you'll lose on an exam. Many multi-level marketers have learned this the hard way.

Our IRS auditor also got hit with penalties:

Petitioner has not shown (or even expressly claimed) that he had reasonable cause or acted in good faith with respect to his understatements of income tax. Any such defense appears especially problematic in the light of petitioner's employment as an IRS auditor.

Ouch.

Cite: Whitecavage, T.C. Memo 2008-203

The TaxProf has more.

Tags: hobby loss.tax court.TaxProf.