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Business losses: Can you deduct them against other income?

Every so often the tax court rules on a case with interesting facts. The distinction between a business and a hobby is often the topic in these cases. A business loss can be deducted, but a hobby loss cannot. Get this wrong and you could owe a large tax bill.

A couple months ago, we wrote a two-part blog series on hobby losses. You can review our January 17 post on the nine-part test that the Internal Revenue Service uses to decide business versus hobby activities.

 

In this post, we will look at the facts of the recent case that concluded the taxpayer did not have a business.

Research for a book series

The taxpayer brought her small children with on a work trip. To keep her kids busy while on the trip to the Czech Republic she wrote a children’s travel guide.

The idea worked and so before traveling with her family, she would write a travel guide draft and fill in details during the trips. She put together four prototype guides for Disney World and a few European Cities. Unfortunately, they were never published and sales were limited to friends and family.

Over the three years she worked on the project, she had $72,000 of expenses for meals and travel. She earned $479 from writing the books. This $71,500 loss was used to offset her income as a practicing attorney.

Not a business

The IRS audited the taxpayer. Tax laws only allow you to deduct losses when you engage in an activity to earn a profit.

In this case, the Service concluded that the taxpayer did not have a for-profit business. Her deduction was reduced to her income – all of $479.

The tax court agreed calling the activity “research in connection with a business she had in mind.” To support the conclusion that there was no business, it looked at her actions over the three year period. She didn’t finalize the guides, hire an agent or submit proposals to publishing companies.

This case is an example of what can go wrong when deducting business losses. If you receive a notice of a tax audit, speak with an experienced tax attorney to learn more.

Source: Forbes, “Tax court holds that family vacation are not deductible as book writing research,” Tony Nitti, Mar. 10, 2016

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