Do you have a Gig activity that you think of as a business? From this Gig activity, are you claiming tax losses on your Form 1040?
Will the IRS consider your Gig activity a business and allow your loss deductions?
The business loss deduction:
- offsets taxable income from other sources;
- reduces your federal income tax bill accordingly;
- and reduces your state income tax bill too, if you have one.
The Problem
The IRS likes to claim that money-losing Gig activities are hobbies rather than businesses. The federal income tax rules for hobbies have been anti-taxpayer for years, and now an unfavorable change enacted in the Tax Cuts and Jobs Act (TCJA) made things even worse for 2018-2025.
If you have such an activity, we should have your attention.
Here’s the deal: if you can show a profit motive for your now-money-losing Gig activity, you can classify that activity as a business for tax purposes and deduct the losses.
Prove Intent
Factors that can prove (or disprove) such intent include:
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- Conducting the activity in a business-like manner by keeping good records and searching for profit-making strategies.
- Having expertise in the activity or hiring advisors who do.
- Spending enough time to justify the notion that the activity is a business and not just a hobby.
- The expectation of asset appreciation: this is why the IRS will almost never claim that owning rental real estate is a hobby, even when tax losses are incurred year after year.
- Success in other ventures indicates that you have business acumen.
- The history and magnitude of income and losses from the activity: occasional large profits hold more weight than more frequent small profits, and losses caused by unusual events or just plain bad luck are more justifiable than ongoing losses that only a hobbyist would be willing to accept.
- Your financial status: “rich” folks can afford to absorb ongoing losses (which may indicate a hobby) while ordinary folks are usually trying to make a buck (which indicates a business).
- Elements of personal pleasure: breeding racehorses is lots more fun than draining septic tanks, so the IRS is far more likely to claim the former is a hobby if losses start showing up on your tax returns.
Takeaways
If you have a money-losing sideline activity, business status is good for your tax health.
Hobby status is bad for your tax health, especially under the TCJA.
You may be able to take advantage of a statutory safe-harbor provision for your money-losing sideline activity.
If a statutory safe-harbor provision is not in the cards, you may be able to take advantage of the fact that the Tax Court has concluded that a number of pleasurable activities can be classified as for-profit businesses rather than hobbies.
So, there’s often a reason for hope. Use the factors listed in this article to evaluate your situation.
The business-versus-hobby issue has been a hot button for the IRS, and the unfavorable TCJA change added fuel to the fire. So before you ever get audited on the issue. It’s important to document that you are on the right side of as many factors as possible.
If you would like to discuss the profit motive, please call me on my direct line at 509-543-7600 or send a request HERE.
February 2022
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