Over the years, there have been numerous court cases involving profit motive and taxes. The verdicts in these cases set critical legal precedents that taxpayers need to understand if this tax topic pertains to them.

Anthony Ranciato v. Com., (1995, CA2) and Ranciato, TC Memo 1996-97 - This case points out that the hobby-loss limits can apply to retail businesses and other traditionally for-profit enterprises. Taxpayers engaging in all activities, not just hobby-type activities, need to operate in a business-like manner and take steps to demonstrate a profit-making intent. The Second Circuit had questioned whether a retail business can be an activity not engaged in for profit and the Tax Court, on review, countered with an emphatic, “Yes, it can.”

Three other cases found that taxpayers lacked a profit objective with respect to businesses typically run for profit: Houston, TC Memo 1995-159 (retail gun store);Ypsilantis, TC Memo 1992-644 (import/export commodities business); and Hutchinson, TC Memo 1988-568 (retail cosmetics business).

Lamb, TC Memo 1996-166, shows that a taxpayer whose business suffers hard times won’t necessarily be challenged when he or she claims losses. IRS denied losses to a fisherman, but the Tax Court ruled against the Service. It ruled that the taxpayer’s failing health, rather than lack of profit motive, business acumen or effort, accounted for the losses.

Drummond v. Comm., TC Memo, 1997 involved a psychologist’s horse and cattle activities. The activities were both determined to be not-for-profit. The taxpayer didn’t show that the cattle were kept for horse pasture management and animals weren’t kept on the same land. The taxpayer didn’t keep adequate books or carry-on horse activities in a business-like manner. He didn’t show that he expected the horses to appreciate in value or prove the horses’ alleged unforeseen injuries affected the profitability.

In Phillips et ux. v. Comm., TC Memo, 1997, a nurse anaesthetist and wife were engaged in Arabian horse breeding for profit, in spite of initial losses. Taxpayers carried on activities in a business-like manner where they have a valid business expansion plan, kept accurate records and calculated income necessary to produce profit. Expansion delays resulted from the wife’s poor health, the death of a champion mare’s 1st foal and the taxpayers’ bankruptcy. The taxpayers tried to cut costs by constructing small barns and attempting to sell some horses.

In Courville v. Comm., CA 9, 79 AFTR 2d 97-1636, a golfing activity was found to be not-for-profit. Taxpayer’s golfing activity was denied in spite of the time and effort the taxpayer put into the activity. The taxpayer didn’t keep complete and accurate records and made no profit in 4 years after beginning the activity. The activity also had recreational and personal elements.

In Kelly v. Comm., TC Memo 1997-185, the court denied deductions for state and local taxes and unreimbursed employee business expenses in excess of the amount the IRS allowed. The taxpayer didn’t prove the claim that her car was used 95% for business. She didn’t show that she made payments on or business use of a leased computer and she didn’t support tax deductions.

Lucid, et ux. v. Comm., TC Memo 1997-247 involved a full-time plastic surgeon and psychotherapist. They couldn’t deduct their S corporation losses from yacht and boating equipment sales due to lack of profit motive. Despite their advertising in boating magazines and their attendance at boat shows, their activities weren’t carried on in a business-like manner.

In F.R. Welch, TC Memo. 2017-229, the Court held that the taxpayer, an economist, was engaged in a ranching activity for profit. Various operations (cattle, hay and horse operations) were one activity that was carried out in a business-like manner for which the taxpayer kept books and records and had separate bank accounts for each operation. Although the taxpayer didn’t have a written business plan, that didn’t not negate a profit motive, because his business plan was evidenced by the actions he took, such as making changes to activities when he realized they were not profitable.

California follows the federal profit motive rules and that a hobby loss is not deductible. However, unlike federal in years 2018-2025, California allows miscellaneous itemized deductions that are subject to the 2% of AGI reduction. Therefore, a hobbyist who itemizes his or her deductions for California will be allowed to deduct hobby-related expenses within the limits described in the “Limit on Deductions and Losses” Section and the “additional limit prior to 2018” provision, which continues to apply for California post-2018.