A loss from a legitimate business activity is fully deductible against other income. If the loss exceeds income, it can be carried forward to offset business income in future years. If an activity is deemed a hobby by the IRS, a loss cannot be deducted. The IRS has many criteria for determining whether an activity is a hobby or a business [See the author’s article on hobby losses for details].
A recent Tax Court case [Herb Vest, TC Memo 2016-187] presents an interesting scenario of what constitutes a hobby versus a business. The case concerned expenses of a taxpayer for activities to investigate whether his father’s death was suicide or a homicide. He spent $6.4 million for private investigators, forensic experts, autopsy, and morticians. One report said his father’s death was likely a homicide but no perpetrator could be found. The taxpayer wrote a manuscript about the suicide and his investigation hoping it could be adapted for a book, TV show, or a movie, but neither resulted. The taxpayer deducted the expenses as a business loss. The IRS denied the loss deduction claiming that this was a hobby under Code Section 183. The taxpayer appealed to the U.S. Tax Court.
The Tax Court upheld the IRS’ loss denial stating that to avoid an activity being considered a hobby, the taxpayer must show there is a dominant hope and good faith intention to earn a profit which was not present in this situation. The Court found that the taxpayer did not have a business plan for determining how he could earn a profit from his investigation and never earned any income from a book, TV show, or movie. Also, the Court said the taxpayer had no expertise to develop or write a book or publish one and did not modify the scope of his activities to minimize his losses. As a result, the loss was not deductible because the Court deemed his activity to be a hobby [Reported in J.K. Lasser’s Monthly Tax Letter, November 2016].