IRS Audit: Expenses And Deductions For Hobbies

IRS Audits On Hobby Expenses And Deductions

Gregory v. Comm’r, T.C. Memo. 2021-115 | September 29, 2021 | Jones, J. | Dkt. No. 10336-18

Short Summary: During tax years 2014 and 2015, Petitioners Carl and Leila Gregory operated CLC Ventures, Ltd. (“CLC”), which generated income and incurred expenses from boat chartering activities. The Gregorys reported CLC’s activities on Schedule C for each tax year. The IRS audited the Gregorys’ tax returns and issued a Notifce of Defiency, assessing deficiencies and certain accuracy-related penalties. The IRS determined that the CLC activities lacked a profit motive and recharacterized (1) the Schedule C income as non-Schedule C “other income,” and (2) the Schedule C expenses as miscellaneous itemized deductions to the extent allowable under Section 183 (with certain exceptions).

On May 29, 2018, the Gregorys timely filed their petition for redetermination of the deficiencies and accuracy-related penalties. On March 6, 2020, the Gregorys filed a motion, requesting that the Tax Court hold as a matter of law that the deductions provided under Section 183(b) for activities not engaged in for profit are not subject to Section 67(a)’s 2-percent floor on miscellaneous itemized deductions.

Key Issues:

  • (1) Whether deductions permitted under Section 183(b) for activities not engaged in for profit are not subject to Section 67(a).

Primary Holdings:

  • (1) Deductions permitted under Section 183(b) for activities not engaged in for profit are subject to Section 67(a).

Key Points of Law:

  • The Tax Court may grant summary judgment when there is no genuine dispute of material fact and a decision may be rendered as a matter of law. Rule 121(b); Sundstrand Corp. v. Comm’r, 98 T.C. 518, 520 (1992), aff’d, 17 F.3d 965 (7th Cir. 1994).
  • Section 183(b)(1) permits a taxpayer to claim deductions, with respect to expenses attributable to their activities that are not predicated on the existence of a profit motive. See Powell v. Comm’r, T.C. Memo. 1986-369, 1986 Tax Ct. Memo LEXIS 242, at *17-*18.
  • Section 63(d) defines itemized deductions as deductions other than (i) those allowable in computing AGI and (ii) the deduction for personal exemptions allowed under Section 151. Section 183(b)(2) is not identified as a deduction allowable in computing AGI. SeeR.C. § 62(a).
  • If an itemized deduction, such as Section 183(b)(2), is not identified on the list provided under Section 67(b), it is a miscellaneous itemized deduction and therefore subject to the restriction provided under Section 67(a). SeeR.C. § 67(b); see also Strode v. Comm’r, T.C. Memo. 2015-117, at *32 n.12.

Insight: As this case suggests, “hobby loss” issues are a regular issue for taxpayers. Moreover, expenses and deductions denied by the IRS as business deductions may be miscellaneouos itemized deductions subject to a 2-percent floor. Accordingly, taxpayers who have relatively high AGIs will likely miss out on these deductions. Further, taxpayers should note that the particular issue highlighted by Gregory is not applicable for tax years affected by the TCJA (i.e., 2018 through 2025).

Have a question? Contact Jason Freeman, Freeman Law, Texas.

Mr. Freeman is the founding and managing member of Freeman Law, PLLC. He is a dual-credentialed attorney-CPA, author, law professor, and trial attorney. Mr. Freeman has been recognized multiple times by D Magazine, a D Magazine Partner service, as one of the Best Lawyers in Dallas, and as a Super Lawyer by Super Lawyers, a Thomson Reuters service.
He was honored by the American Bar Association, receiving its “On the Rise – Top 40 Young Lawyers” in America award, and recognized as a Top 100 Up-And-Coming Attorney in Texas. He was also named the “Leading Tax Controversy Litigation Attorney of the Year” for the State of Texas” by AI.

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