What is Worse Than a Hobby?

Gregory Carnes, Contributor, South-Western Federal Taxation Series. What is worse than a hobby that generates revenue? Nothing!! This is especially true after the Tax Cuts and Jobs Act 2017. There are limitations on deductions that apply to activities that are considered a hobby or business. These restrictions, which have been in effect for many years, include: The amount of expenses that can be deducted cannot exceed the revenue earned. Expenses must also be deducted in a specific order: Cash expenses Depreciation, amortization, and items that would be deductible even if the hobby is not included. Expenses in category two and three are miscellaneous deductions subject to the floor of 2%. Before 2018, these rules made it difficult to get a tax benefit from hobby-related deductions Because they were deductible even without the hobby, items in category one did not produce a tax benefit. These items were also less expensive than the revenue earned so it was more difficult to get a tax benefit from categories two or three. Taxpayers who took the standard deduction did not receive any benefit from categories two or three. For taxpayers who did itemize, the benefits from categories two or three depended on how much the total miscellaneous deductions exceeded 2 percent of AGI. These rules were difficult for taxpayers. But, the situation is worse now. The Tax Cuts and Jobs Act of 2017, which covers 2018-2025, has the deduction for miscellaneous itemized deducts suspended. This is in addition to the 2%-of AGI floor. Taxpayers will not be able to claim any tax benefits from deductions in the categories two and three above. A taxpayer who has a hobby must report all revenues. However, expenses incurred to earn the revenue cannot be deducted. Let’s say Amanda earns $8,000 in hobby income in 2019. While earning the revenue, she also has to pay $12,000 in cash expenses (which are not deductible). She will report $8,000 in income and not have any deductions, even though she has ($4,000) cashflow. These are some topics that you and your students might find interesting for discussion. Are the current rules regarding hobby losses fair for taxpayers like Amanda in the example above? What rules apply to gambling income? What rules apply to illegal business operations? These rules are different from the rules that apply to hobby deductions. These differences are justified? What would you recommend to Congress as an alternative policy regarding deductions for hobbies? Ideas for Class Assignments Students should write a paper describing the similarities and differences between the deduction rules for gambling, hobbies, and illegal businesses. Assign a student to discuss one side of this issue with another student/group: Taxpayers who suffer from losses due to hobbies are treated equally to those who suffer gambling losses or have illegal businesses. Students should write a letter to Congress expressing their concerns about the current rules regarding hobby losses and offering an alternative. Resources https://www.marketwatch.com/story/you-cant-deduct-hobby-related-expenses-under-the-new-tax-lawbut-do… https://www.americanbar.org/groups/taxation/publications/abataxtimes_home/18mar/18mar-ylc-roarty-hob… SWFT Chapters SWFT Individuals: Chapter 6 Interested in earning FREE CPE Credit? To be added to the Cengage Account Executive mailing list for future events, please contact them! Visit our events page to view recorded webinars.