This post from 2011 is quite popular. It’s about a person in Minnesota who had a drag racing team which showed substantial losses each year. He took those losses as business deductions on his tax return, but the IRS and Tax Court said “no.”
The moral is: if you say your “business” had $350 of revenue and $60,000 of expenses, and you do this year after year, the IRS will likely go “hmmmm” at some point.
A taxpayer from Minnesota lost a Tax Court case earlier this month in which he tried to claim business deductions related to his drag racing team. The taxpayer, a Mr. Zenzen, reported business income of $850 in 2005; $950 in 2006 and $350 in 2007. This income was offset with expenses ranging from $25,000-$60,000 each year, which created large business losses on Mr. Zenzen’s returns. This drew the attention of the IRS, which disallowed the deductions. The Tax Court sided with the IRS on the grounds that the drag racing endeavor was a hobby rather than a business.
A number of factors worked against Mr. Zenzen. One is that his drag racing team was not his primary source of income. Both he and his wife had W-2 jobs and made over $100,000 in combined income from those jobs in the years in question.
Mr. Zenzen has been involved in drag racing since 1970, and has had his own team since 1988. He told the Court that his drag racing team was a hobby up through 2005, when he believed it rose to the level of a business. Zenzen often put in 30+ hours per week working on his cars with his two children. The Court agreed that Mr. Zenzen put in a lot of time, but:
While this fact tends to favor (Zenzen’s) position, (Zenzen) also derived substantial enjoyment from drag racing. For over 30 years (Zenzen) considered drag racing a hobby — it is unlikely that in 2005, 2006 and 2007 (Zenzen) ceased to derive similar enjoyment from the activity …. The time (Zenzen) devoted to his drag racing activity was also time (Zenzen) spent with his children.
The Court also found other factors working against Mr. Zenzen:
At no time did (Zenzen) have a written business plan for his drag racing, and he did not maintain a general ledger, annual budget and expense forecasts, or a separate bank account relating to his drag racing activity …. At no time before 2005 or during the years in issue did (Zenzen) speak with a business adviser about ways to make a profit in drag racing.
Mr. Zenzen did keep receipts, but the Court said that’s not enough:
There is no evidence that (Zenzen) used these receipts as a management tool to reduce expenses or increase profitability. (Zenzen) offered no evidence of how comparable profitable businesses operate.
The Court opinion is good reading for anyone who wonders if their hobby might be at the level of being considered a business for tax purposes. You can read the entire Court opinion here.