A drag racing enthusiast has failed to persuade the Tax Court that his sport was a business and not a hobby. The Tax Court acknowledged the taxpayer’s long experience in drag racing but found that experience did not equate to business expertise. This and other factors indicated that the taxpayer lacked a genuine profit objective in drag racing.
In 1970, the taxpayer began participating in drag racing. At first, he volunteered as a crew member and mechanic for various drag racing teams. The taxpayer purchased a drag racing car in 1988 and entered races. In subsequent years, he purchased additional cars and entered more races.
During race seasons, the taxpayer typically would spend about 30 hours per week preparing the race cars. This time was in addition to the time spent participating in weekend races. The taxpayer also worked a full-time job unrelated to drag racing.
On his 2005, 2006 and 2007 federal income tax, the taxpayer reported more than $100,000 in losses related to drag racing on Schedule C. The IRS disallowed the losses; determining that the taxpayer’s drag racing was not an activity engaged in for profit.
The IRS and the courts use a number of factors to determine if an activity is for profit or is a hobby. Some of the factors are (not an exhaustive list):
- Does the time and effort put into the activity indicate an intention to make a profit?
- Does the taxpayer depend on income from the activity?
- If there are losses, are they due to circumstances beyond the taxpayer’s control or did they occur in the start-up phase of the business?
- Has the taxpayer changed methods of operation to improve profitability?
- Does the taxpayer have the knowledge needed to carry on the activity as a successful business?
- Does the taxpayer expect to make a profit in the future from the appreciation of assets used in the activity?
Hobby not business
In this case, the court found that the taxpayer drew substantial enjoyment from drag racing. The taxpayer enjoyed traveling to weekend race events, watching his team participate in events, and developing friendships with individuals involved in drag racing.
The court also found that the taxpayer did not maintain books or written records, had no formal business plan, and did not create annual budget and expense forecasts relating to drag racing. Although a taxpayer is not required to maintain a sophisticated system of accounting, a taxpayer should keep documents that allow the taxpayer to make informed business decisions, the court noted.
The court further found that the taxpayer’s drag racing generated minimal income. The losses the taxpayer incurred in connection with his drag racing activity were over 54 times the amount of income earned.
The court concluded that the taxpayer lacked good faith intent to make a profit from his drag racing activities. The court upheld the IRS’s disallowance of his drag racing losses.