The rules for reporting the income and expenses associated with a “hobby” or “pastime” is dependent upon whether or not the activity has the genuine purpose of making a profit. The Herb Vest case is an interesting Tax Court Memorandum decision regarding a wealthy taxpayer’s attempt to deduct from gross income, expenses related to the investigation of his father’s mysterious death. Among several issues discussed in the case, the Tax Court discussed not-for-profit activities and the factors considered in determining profit objective.
In 1946, when the taxpayer was an infant, his father was found hanging by the neck at his business in Gainesville, Texas. Authorities originally ruled it a suicide, but Vest received an anonymous letter in 2003 claiming his father was actually murdered and those responsible made it look like a suicide. Having become wealthy due to the sale of his business in 2001, Vest had the financial resources to expend substantial time and resources to investigating the true circumstances of his father’s death.
If a taxpayer engages in an activity for sport or recreation rather than to make a profit, generally, this would establish the activity as a hobby. But of course, it’s not this simple. The IRS has established nine factors that taxpayers should consider in assessing whether or not their particular activity is a business or hobby.
In Herb Vest, the Tax Court identified this non-exhaustive list of nine factors provided by the tax regulations to be considered in determining whether a taxpayer conducts an activity with the intent to earn a profit. The factors listed are:
- the manner in which the taxpayer conducts the activity;
- the expertise of the taxpayer or his advisers;
- the time and effort spent by the taxpayer in carrying on the activity;
- the expectation that assets used in the activity may appreciate in value;
- the success of the taxpayer in carrying on other similar or dissimilar activities;
- the taxpayer’s history of income or loss with respect to the activity;
- the amount of occasional profits, if any;
- the financial status of the taxpayer; and
- elements of personal pleasure or recreation.
No factor or group of factors is controlling, nor is it necessary that a majority of factors point to one outcome. Certain factors may be accorded more weight in a particular case because they have greater salience or persuasive value as applied to its facts.
Vest did not generate a single dollar of revenue from his investigative activities in any year from 2003 through 2010. Over this period of time, Vest’s reported losses were continuous and substantial, strongly suggesting that he did not engage in this activity to make a profit.
The Tax Court found that Vest had no business plan. Characteristics of a businesslike operation include the preparation of a business plan. The Tax Court found that Vest did not conduct his activity in a businesslike manner.
Also, Vest never adjusted the scale or direction of his activities as a profit-maximizing person would under similar circumstances. He did not modify his operations as his losses continued to increase. He had no expectation that assets used in his investigative activity would appreciate in value. Also, when the chance for profit is small relative to the potential for gratification or self-fulfillment, the latter is more likely the true motivation of the taxpayer.
In conclusion, the Tax Court found that Vest did not incur the expenses related to the investigation of his father’s death in an activity conducted with the genuine purpose of making a profit. Thus, under § 183 of the Internal Revenue Code, the number of allowable deductions attributable to his investigative activity was limited to the gross income which he derived from such investigative activities. Since Vest received no gross income from the activities during 2008-2010, he was not entitled to any deductions.
Many provisions of the Internal Revenue Code are complicated. Proper interpretation of the rules and regulations contained in these provisions requires the assistance of an experienced and knowledgeable tax professional. If you have questions about whether a profit-making activity in which you participate is a hobby or business, contact THE TAX EXPERTS at the Thorgood Law Firm www.thorgoodlaw.com. For a FREE consultation, call 212-490-0704.
