Judicial Interpretation of Hobby versus Business Activities: An Analysis of Treasury Regulation §1.183-1(b) from 2005 to 2015

• In Event: Potpourri (Accounting Behavior and Organizations and Tax)

Abstract

Internal Revenue Code §183 generally prohibits taxpayers from deducting expenses related to activities not primarily motivated by profit. This paper reviews the federal Tax Court’s application of the nine factors outlined in Treasury Regulation §183 in a sample of decisions from 2005 to 2015, and examines marginal impact on probability of taxpayer success for each additional factor the taxpayer satisfies. We find that the probability of winning the case increases substantially for a taxpayer who demonstrates three factors (60%) compared to a taxpayer who demonstrates only two factors (23%). Consistent with extant literature we observe that operating in a businesslike manner is the key factor in the court’s decisions. We also examine the importance of legal counsel in such cases. Although represented taxpayers win more often, pro se taxpayers enjoy a greater marginal benefit (i.e., their likelihood of success rises more quickly) with each additional factor win.

Authors

• John Cook, Wright State University

• Kathryn E Easterday, Wright State University

• Sarah Jean Webber, University of Dayton