Renee - Side Consultancy: Hobby or Business?
Renee is single, age 41, and works full time as a hospital RN earning $92,000 in W-2 wages. Since 2021 she has sold herbal remedy consultations on the side. Results: 2021 loss $9,400; 2022 loss $12,100; 2023 profit $1,150; 2024 gross receipts $18,400 and expenses of $24,800. The 2024 expenses are $7,000 paid to a contract formulator, $6,500 for travel to three conferences, $3,300 website and social media, $2,100 supplies, $1,800 continuing education, $1,260 home office (180 of 2,000 square feet) and $2,840 of mileage (4,240 miles). She has 14 customers, no business plan, no separate bank account until 2024, and advertises only through her personal Instagram. She spends 10-12 hours a week on the activity, mostly evenings and weekends, and calls it "her passion."
1. Is Renee's consulting activity an activity engaged in for profit under §183? Walk through the factors that matter on these facts, then state a conclusion and explain the burden of proof and the 3-of-5-year rule.
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Framework. §183 disallows losses from an activity not engaged in for profit. No single factor controls; the question is whether the taxpayer had an actual and honest objective of making a profit, judged on objective facts (Reg. §1.183-2(b) lists nine factors: manner of carrying on the activity, expertise, time and effort, expectation of asset appreciation, success in similar activities, income/loss history, losses from unforeseen causes, ability to profit, and personal pleasure).
Applied. For a profit motive: 10-12 hours a week, 14 paying customers, real revenue, genuine expertise. Against: four years of losses against one $1,150 profit, and a $6,400 loss in a year with $18,400 of revenue; no separate books or bank account until 2024; no plan, pricing analysis, or marketing beyond a personal account; the activity is her stated passion; and the losses shelter $92,000 of wages, which is a tax benefit, not a profit motive.
Conclusion. On these facts the profit objective is doubtful and the IRS would likely prevail. The burden is on Renee because the IRS determination is presumptively correct. The §183(d) presumption (3 profitable years in 5 consecutive years ending with the current year) does not help her - she has one in four - though she could elect under §183(e) to postpone the determination until she has five years of results.
2. Assume the activity is not for profit. What does Renee report for 2024, and what happens to the $24,800 of expenses, her self-employment tax, and the §199A deduction?
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Income. The $18,400 of receipts is gross income, reported as other income on Schedule 1 - not on Schedule C. It is fully taxable.
Expenses. §183(b) allows deductions in tiers: (1) amounts allowable regardless of profit motive (mortgage interest, real property taxes, casualty losses); (2) amounts that do not reduce basis, allowed only to the extent of gross income; (3) amounts that reduce basis (depreciation), allowed only to the extent of remaining gross income. For 2018-2025, §67(g) suspends miscellaneous itemized deductions, so tier (2) and tier (3) are zero - the formulator fee, mileage, supplies, website, education, and conference travel are not deductible at all, and there is no home office deduction or depreciation. The only survivor is the roughly 9% of home mortgage interest and real property taxes allocable to the 180-square-foot office, deductible only if she itemizes and stays within the §164(b) SALT cap. Hobby expenses do not carry forward.
Other effects. No Schedule SE and no self-employment tax. The $18,400 is not QBI, so no §199A deduction. It is not earned income, so it supports no IRA contribution and no earned income credit.
3. Renee asks whether better recordkeeping now, or amending 2021-2023, would change anything. What do you tell her?
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Records help prospectively, not retroactively. The factors are judged on objectivity, so the fixes are: a dedicated bank account and card, a written business plan with projections and pricing, documented marketing spend, a mileage log, invoices, and evidence she is trying to become profitable (raising prices, dropping money-losing services, tracking cost per client). Three profitable years out of five would shift the §183(d) presumption to her side; the §183(e) election lets her defer that determination.
Amending 2021-2023 mostly does not help. The numbers are already on filed returns, and amending cannot cure the profit-motive question. Refunds are also limited by §6511 (later of 3 years from filing or 2 years from payment), so 2021 is likely already closed. Amending to recharacterize losses would only create tax, penalties, and interest.
Real risk to flag. If the IRS disallows the 2021-2023 losses, the §6662 accuracy-related penalty is in play unless she has substantial authority or reasonable cause. Hobby loss is a facts-and-circumstances area; the contemporaneous records are her defense. Recommend a written position memo documenting the analysis and the §183(e) decision each year.