TIGTA: Hobby Loss Rule Hobbled

The Office of the Assistant Secretary of the Treasury for Tax Policy will propose legislative changes to IRC section 183 to strengthen and clarify the hobby loss rule. The office agreed to do so at the urging recently of the Treasury Inspector General for Tax Administration, which faulted the statute’s language in part for what TIGTA said was probable widespread abuse. Treasury also will highlight the topic in messages to practitioner organizations.

Although violations of the hobby loss rule probably account for a sizable portion of the estimated $30 billion a year in unpaid taxes resulting from improper deductions, exemptions and credits, the IRS is unable to gauge the extent of the problem or effectively target compliance efforts, TIGTA said in the report.

About 1.5 million taxpayers claimed net losses on Schedule C that reduced their income from other sources in each of four consecutive years (2002–2005)—possible evidence of improper deductions, TIGTA said. Nearly three-quarters of those taxpayers (73%) were assisted by tax practitioners, the report noted.

Among the hurdles the IRS faces in improving compliance is the hobby loss rule itself, as codified in IRC section 183 and corresponding regulations, TIGTA said. The section prohibits claiming a net loss from an activity that isn’t a trade, business or income-producing activity—in other words, a hobby. Regulations require only the “objective” of making a profit; a better requirement would be a “reasonable expectation” of profitability, TIGTA said.