Reform “hobby” rules for equity and possible improved compliance

Following up on my 6/25/23 post about an idea I included in testimony submitted for the written record of a small business tax complexity hearing held on June 7, here is another idea I proposed:

Reform “hobby” rules for equity and possible improved compliance

IRC Section 183, Activities not engaged in for profit, imposes limitations on deductions for activities that generate revenues but not IRC Section 162 deductions. Under this provision, deductions are allowed up to the amount of gross income from the “hobby”, with gross income measured as receipts less cost of sales. The allowed deductions though are only deductible if the taxpayer itemizes deductions and are treated as miscellaneous itemized deductions subject to the 2-percent-of-AGI threshold of IRC Section 67. For 2018 through 2025, such deductions are not allowed at all.

IRC Section 183 should be reformed to treat the allowable deductions as deductible for AGI, but still limited to gross income without any carryforward if deductions exceed gross income. The Joint Committee on Taxation defines the “normal structure” of the individual income tax as including deductions for investment and employee business expenses. [JCT, Estimates Of Federal Tax Expenditures For Fiscal Years 2022-2026, JCX-22-22 (Dec. 22, 2022), page 4]  The logic for this is that these expenses are incurred to generate taxable income and a “normal” income tax would allow such deductions. This argument also justifies allowing a deduction for the reasonable expenses of producing hobby revenues.

Another benefit of reforming IRC Section 183 is that it may reduce the inclination some taxpayers might have to treat a hobby as a business in order to claim the deductions for AGI.

What do you think?