Client Login

Hobby Losses Tax Case Lesson: Have a Business Plan

An article written by Peter J Reilly from ( highlights the need for taxpayers who have business losses on their tax return to document their objective of making a profit by having a business plan:

Musician Wins Hobby Loss Case

Thomas Gullion is serious about his saxophone playing and the Tax Court agrees.  I like Tax Court Summary opinions.  They are the reality TV of the system.  What is really great is when pro se taxpayers win summary opinions.  It kind of helps me keep some faith in the system.  You would not want it to happen too often, though, because the IRS should not be bringing stupid cases to Tax Court.  People with solid positions should have no change audits or prevail at appeals.

Mr. Gullion was being audited for 2008 and 2009.  There was about $20,000 in tax and penalty at stake.  The issue was whether his musical activities had the “objective of making a profit within the meaning of Section 183″.  We call cases like this “hobby loss” cases.

Revenue agents have the same educational background as CPAs, so I fancy that I can see things from their point of view.  In 2008 and 2009 Mr. Gullion and his wife had income somewhat over $100,000 per year which was sheltered by losses from his music business.  From 2004 to 2010, total losses were over $130,000 with gross revenue of just over $13,000 (in total for all those years).  It is going to be hard to get a no-change audit out of those numbers.  Also with those numbers I bet my most loyal commenter, Robert Baty, a retired IRS appeals officer, already has Mr. Gullion locked up and is contemplating what to do with the key.

Mr. Gullion was able to convince the Tax Court that he was trying to make money, primarily by showing them that he had a plan.

Petitioner was dedicated to his music career. He organized a jazz festival in Wisconsin and recorded four CDs, including “Carswell” in 2009. Petitioner’s testimony was credible concerning the time he spent on his music career.

Petitioner testified that the music industry has undergone changes over the years and that it is now difficult to make a profit. He testified that many of the jazz clubs closed in Chicago and that there were not that many opportunities. He further testified that less money is made when a musician plays another artist’s music. Petitioner contends that he made changes so he can become profitable. Petitioner moved to Wisconsin in part because the cost of living was lower and because he could continue to travel to Chicago and elsewhere. For instance he will embark on a tour in Spain in summer 2013. He referred to his time in Wisconsin as rebuilding years and stated that he would like to be able to leave the software industry and pursue music full time. In addition petitioner wanted to change the course of his career, placing more emphasis on his own music and focusing on composing. He wants to leave behind a legacy of work.

Respondent contends that petitioner’s small profit in 2011 could not offset years of sustained losses that total over $100,000; however, petitioner was able to explain these losses. The music industry changed, and petitioner’s focus moved from performance to original composition and other aspects of music. Petitioner contends that he made adjustments and retooled his career and that he was profitable in 2011. A result of this retooling was the CD “Catharsis”, which includes his original compositions.

I asked Mr. Gullion for his thoughts on how the system worked for him.  He told me that his accountant had not cautioned him about the potential for hobby loss.  Since he was working on an album and buying equipment, he might have been able to avoid problems while preserving his ultimate deductions by being aggressive in capitalizing rather than expensing.  Of course that would have hurt his current cash flow.

As far as the audit goes:

The initial auditor mischaracterized almost all facts in my case (stating that I moved to the country in Wisconsin as part of an elaborate tax dodging scheme) and made wild, unsubstantiated judgments (such as “it’s impossible to make a living as a musician in rural America”). The appeals officer wouldn’t consider examining the facts in the case at all.

I call that phenomenon “the agent from hell”.  I’ve only had it happen a couple of times in my career, but that’s why they have Tax Court, I guess.  Mr. Gullion had not planned on going pro se, but:

I hired a lawyer who burned through almost $7K in writing a draft response to the IRS. It turned out to be one of the worst papers I’ve ever read. Completely unusable. So I found myself in the unhappy position of having to go to US Tax Court and represent myself.

I think this case is another example of the importance of a business plan in winning a hobby loss case.  I don’t know if a more formal business plan might have helped at the agent level, but if you are posting losses in a side business, be sure to have one.

Industry News

Read All Articles

January 8, 2016


Do you have a question or need more information about our services? Complete the form below, and we'll be in touch with you.

Saunders Nydegger, PC

286 N. Gateway Dr. Ste. 202
Providence, UT 84332


© Saunders Nydegger, PC.
Se Habla Espanol