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.