Question

now quipcu. 7.34 Hobby Expenses-Effect on AGI, C is a successful attorney and stock car racing enthusiast. This year she decided to quit watching the races and start participating. She purchased a car and entered several local races. During the year, she had the following receipts and disbursements related to the racing activities: Race winnings ........ $3,000 Property taxes. 2,800 Fuel, supplies, maintenance..... 1,000 Her AGI exclusive of any items related to the racing activities is $100,000. a. Indicate the tax consequences assuming the activity is not considered to be a hobby. b. Assuming the activity is treated as a hobby, what are the tax consequences? c. Assuming the activity is deemed a hobby and property taxes are $4,000, what are the tax consequences? d. What is the critical factor in determining whether an activity is a hobby or a business? e. What circumstances suggest the activity is a business rather than a hobby?

Answer 1

1. If the activity is not considered to be a hobby and is considered to be a business, the income from the activity needs to be reported on Schedule C and the expenses can be deducted as cost of doing business. If the activity suffers losses instead of gains, same can be used to offset the income received from other sources.
2. If the activity is a hobby instead of business, hobby income must be reported on line 21 “Other income” of Form 1040. Further, hobby expenses were allowed as a deduction upto the amount of hobby income prior to 2018, but the same has been disallowed post-2018,i.e., after 2018 hobby income must be reported but hobby expenses cannot be claimed. Prior to 2018, hobby expenses could be deducted as itemized deductions subject to 2% of adjusted gross income and not exceeding hobby income.
3. If the activity is deemed to be a hobby, no hobby expenses are allowed as deduction post 2018. So, race winnings of $3,000 will be fully taxable.
4. As per IRS, the critical factor in determining whether an activity is a hobby or business is profit-motive. A hobby is an activity done for recreational or pleasure purpose (where the main objective is not to earn profits although profits may arise out of hobby) while business is done with a purpose to earn profit.

E. As per IRS , following circumstances suggest whether an activity is a hobby or business:

“

• Whether you carry on the activity in a businesslike manner and maintain complete and accurate books and records.
• Whether the time and effort you put into the activity indicate you intend to make it profitable.
• Whether you depend on income from the activity for your livelihood.
• Whether your losses are due to circumstances beyond your control (or are normal in the startup phase of your type of business).
• Whether you change your methods of operation in an attempt to improve profitability.
• Whether you or your advisors have the knowledge needed to carry on the activity as a successful business.
• Whether you were successful in making a profit in similar activities in the past.
• Whether the activity makes a profit in some years and how much profit it makes.
• Whether you can expect to make a future profit from the appreciation of the assets used in the activity.”