Tax Court Decides If Taxpayer's Coaching Business is a Hobby
(Parker's Federal Tax Bulletin: November 24, 2012)

Most hobby loss cases involve horses or yachts. But recently, the Tax Court was asked to decide whether a taxpayer's coaching business, which had losses for eight straight years and a profit of $43 in the ninth year, was really an activity not engaged in for profit. In Parks v. Comm'r, T.C. Summary 2012-105 (10/25/12), the Tax Court rejected the IRS's arguments and held that the coach could take a Schedule C deduction for his expenses. In so holding, the Tax Court concluded that the coach did all the right things, except make a profit, to show that his activity was not meant as a hobby. The case is instructional for preparers who have clients operating businesses at a loss and who run the risk of having the IRS deny their deductions under the hobby loss rules.

Observation: The court also noted that, in the the years following the years at issue, the taxpayer's income was increasing and deductions were decreasing - mostly due to the taxpayer turning a gang member into a world class Olympic athlete. In addition, while not mentioned in the facts of the case, the court did include in its evaluation of the factors to be considered the fact that the taxpayer's marriage and personal life were negatively affected by the fact that he devoted a large portion of his nonemployment time to his private coaching activity.

Facts

John Parks graduated from Auburn University with a degree in communications/journalism and broadcasting. He received a master's degree in 1995 from the University of Montevallo with a certification in secondary education. He began his coaching career in 1984, and from 1988 to 1991 he served as the assistant track coach at Auburn, where he was responsible for, among other things, camps and clinics sponsored by Auburn.

John worked in writing and publishing. He published freelance articles for various publications on track and field, and at one point he was the editor, publisher, and owner of a cross-country running magazine. From August 1999 through May 2006, he worked as a track coach at McKay High School in Salem, Oregon. During 2006 through 2008, John was a teacher and an athletic coach specializing in track. From February 2007 through June 2008, he worked as a track coach at Stayton High School in Stayton, Oregon. After that, he worked as an assistant track coach at Portland State University in Portland, Oregon. In 2012, he was a teacher at West Salem High School, assistant track coach at Oregon State University, and an athletic coach for Nike.

In 2006, John stopped writing and publishing and began devoting a substantial portion of his nonemployment time to a private track and field coaching activity. In October 2006, he consulted with Loren Seagrave concerning ways to increase the profitability of his private coaching activity. Seagrave is recognized as an expert in sprint and power development and coaches several Olympic and world champion track athletes. John paid Seagrave for his advice, which was to speak at more regional and national clinics, training camps, and universities. He also advised John to advertise and develop opportunities to enter the professional track ranks by showcasing the abilities of his most gifted runners.

After receiving Seagrave's advice, John focused more on college and professional runners and started conducting more track camps and clinics. John also began focusing more time on a running club that he ran from 2003 through 2008. He charged $125 to $200 per participant, depending on the season. He usually had between 12 and 20 participants and hoped to expand that to 80 or 100. However, during 2006, John lost the use of the McKay track facilities he had been using for his private coaching and had to use substandard facilities at a community college. In February 2007, although he continued to teach at McKay, John became the track coach at Stayton and was able to use the track facilities there for his private coaching. The travel between these locations and the loss of several of his private coaching athletes (caused by the loss of the McKay track facilities) were detrimental to John's private coaching activity, and as a result his 2006 year was unprofitable. In spite of these setbacks, John continued to pursue his private coaching activity.

John's 2007 year was also unprofitable because some of the athletes he was coaching at the time qualified for national meets, and he incurred large expenses for travel. John believed that national exposure of his athletes would eventually lead to more coaching opportunities, including coaching professional athletes. John's 2008 year was unprofitable for reasons similar to those he encountered during 2007.

In 2006, John began training a high school student and former gang member, Ryan Bailey. In the summer of 2008, Bailey became a qualifier for the Olympic trials in Eugene, Oregon. Bailey ran the sixth-fastest time for an American runner in the 100 meters, and his race times indicated that he was one of the world's fastest runners in the 100- and 200-meter distances. In 2009, John became Bailey's professional coach and manager and entered into a contract with Bailey that entitled John to $5,000 for 2009 and $10,000 in subsequent years, plus a percentage of any bonus that Nike agreed to pay Bailey. As a result, John's reputation and the quality of athletes he coached improved and continued to improve through the time of the Tax Court trial.

IRS Adjustments

John's wages from being a teacher and track coach during 2006, 2007, and 2008 were approximately $56,000, $56,000, and $65,000, respectively. John kept records for his private coaching activity on a computer, and he entered income from coaching contemporaneously on the computer. He also maintained all of his expense receipts for his activity and periodically recorded them on the computer. For years 2003-2011, John had income of $87,000 from his coaching business and expenses of $240,631. The only year he showed a net profit was in 2011 and the profit was $43.

The IRS audited John's 2006 through 2008 tax returns and reclassified John's expenses for all three years from Schedule C, Profit or Loss From Business, to Schedule A, Itemized Deductions, so that expenses in excess of income were not deductible, thereby generating income tax deficiencies. According to the IRS, John's private coaching activity was an activity not engaged in for profit within the meaning of Code Sec. 183.

Hobby Loss Rules

If an individual engages in an activity but does not engage in that activity for profit, no deduction attributable to that activity is allowed, except as provided in Code Sec. 183. Code Sec. 183(b)(1) allows deductions that are otherwise allowable without regard to whether the activity is engaged in for profit, and Code Sec. 183(b)(2) allows deductions that would be allowable if the activity were engaged in for profit, but only to the extent the gross income derived from the activity exceeds the deductions allowable by reason of Code Sec.183(b)(1). Code Sec. 183(c) defines an activity not engaged in for profit as any activity other than one with respect to which deductions are allowable for the tax year under Code Sec. 162 or under Code Sec. 212(1) or (2).

To take a deduction under Code Sec. 162 or Code Sec. 212(1) or (2), the taxpayer must establish that he engaged in the activity with the predominant, primary, or principal objective of realizing an economic profit independent of tax savings. Although a reasonable expectation of profit is not required, the facts and circumstances must indicate that the taxpayer entered into the activity, or continued the activity, with the actual and honest objective of making a profit. In making this determination, more weight is accorded to objective facts than to the taxpayer's statement of intent.

Factors the courts consider in determining whether an activity is engaged in for profit include: (1) the manner in which the taxpayer carries on the activity; (2) the expertise of the taxpayer or his advisers; (3) the time and effort expended by the taxpayer in carrying on the activity; (4) the expectation that assets used in the activity may appreciate in value; (5) the success of the taxpayer in carrying on other similar or dissimilar activities; (6) the taxpayer's history of income or losses with respect to the activity; (7) the amount of occasional profits, if any, that are earned; (8) the financial status of the taxpayer; and (9) the elements of personal pleasure or recreation. All facts and circumstances are to be taken into account, and no single factor or group of factors is determinative.

Tax Court's Analysis

The Tax Court examined the nine different factors and concluded the following with respect to each factor:

(1) Manner in Which Business Was Carried On: The court found that John maintained receipts and concurrently entered the income received into a computerized recordkeeping system and, within a reasonable time, transferred expense information to the system. He sought the professional help of Seagrave, who advised him on approaches for a more successful and profitable coaching business. By following Seagrave's advice, John began coaching more athletes with higher potential, including one with a worldwide reputation. Overall, the court stated, John's approach to his coaching activity was businesslike, and he sought ways to improve his success, including the abandonment of his journalistic pursuits. Thus, this factor weighed in John's favor.

(2) Expertise of the Taxpayer or His Advisers: There was no doubt in the court's mind that John had the expertise to coach track and field. Thus, this factor was favorable to John.

(3) Time and Effort Expended in Carrying on the Activity: The court found that John spent a substantial portion of his nonemployment time on his private coaching activity. While not mentioned in the facts of the case, the court also noted that John's marriage and personal life were negatively affected by the fact that he devoted a large portion of his nonemployment time to his private coaching activity. Accordingly, the court found this factor to be favorable to John.

(4) The Expectation That Assets Used in the Activity May Appreciate in Value: No significant assets were used in connection with John's activity, rendering this factor neutral.

(5) The Success in Carrying on Other Similar or Dissimilar Activities: The court noted that before 2006 John did not carry on similar or dissimilar activities. Other than his publication activity, John's source of income was his employment as a teacher and a coach. Accordingly, the court found this factor to be neutral.

(6) History of Income or Losses with Respect to the Activity: While noting that the three years before the court were loss years, the court also looked at the three years following the years at issue and found that John's expenses dropped and gross receipts rose precipitously so that by 2011 he cleared a modest profit. However, the court said that although it appeared that John was attempting and succeeding in the pursuit of more profitable approaches to his coaching activity, the first five years in the activity resulted in continuous losses, causing this factor to weigh against John.

(7) The Amount of Occasional Profits, if Any, That Are Earned: The court concluded that although John improved his potential for gain, the continued losses without meaningful gain were a factor that weighed against John for this analysis.

(8) Financial Status: The court found that the expenses John incurred in his private coaching activity were not intended to produce substantial tax benefits by reducing ordinary income. In these circumstances, the court observed, it is more likely that the expenses were a financial hardship to John, reducing the amount available for his living expenses. Thus, the court found this factor weighed in John's favor.

(9) Elements of Personal Pleasure or Recreation: The court noted that John's professional and personal pursuit has always been teaching and coaching. This pursuit, the court observed, is difficult to label as a hobby, despite that fact that John might derive personal pleasure from his involvement. On the basis of the amount of nonemployment time expended and the nature of the activity, the court found that this factor weighed in John's favor.

Thus, of the nine factors, the Tax Court found five favorable, two unfavorable, and two neutral. The unfavorable factors, the court noted, involved John's history of income and losses and whether he earned profits. With respect to those factors, the court noted that John's income was increasing, losses were decreasing, and his potential for success improving. Ultimately, the court found and held that John was engaged in his private coaching activity for profit for his 2006, 2007, and 2008 tax years and that his deductions were not limited by Code Sec. 183.

(Staff Editor at Parker Tax Publishing)

Disclaimer: This publication does not, and is not intended to, provide legal, tax or accounting advice, and readers should consult their tax advisors concerning the application of tax laws to their particular situations. This analysis is not tax advice and is not intended or written to be used, and cannot be used, for purposes of avoiding tax penalties that may be imposed on any taxpayer. The information contained herein is general in nature and based on authorities that are subject to change. Parker Tax Publishing guarantees neither the accuracy nor completeness of any information and is not responsible for any errors or omissions, or for results obtained by others as a result of reliance upon such information. Parker Tax Publishing assumes no obligation to inform the reader of any changes in tax laws or other factors that could affect information contained herein.

Parker Tax Pro Library - An Affordable Professional Tax Research Solution. www.parkertaxpublishing.com

We hope you find our professional tax research articles comprehensive and informative. Parker Tax Pro Library gives you unlimited online access all of our past Biweekly Tax Bulletins, 22 volumes of expert analysis, 250 Client Letters, Bob Jennings Practice Aids, time saving election statements and our comprehensive, fully updated primary source library.

Try Our Easy, Powerful Search Engine

A Professional Tax Research Solution that gives you instant access to 22 volumes of expert analysis and 185,000 authoritative source documents. But having access won’t help if you can’t quickly and easily find the materials that answer your questions. That’s where Parker’s search engine – and it’s uncanny knack for finding the right documents – comes into play

Things that take half a dozen steps in other products take two steps in ours. Search results come up instantly and browsing them is a cinch. So is linking from Parker’s analysis to practice aids and cited primary source documents. Parker’s powerful, user-friendly search engine ensures that you quickly find what you need every time you visit Our Tax Research Library.

Dear Tax Professional,

My name is James Levey, and a few years back I founded a company named Kleinrock Publishing. I started Kleinrock out of frustration with the prohibitively high prices and difficult search engines of BNA, CCH, and RIA tax research products ... kind of reminiscent of the situation practitioners face today.

Now that Kleinrock has disappeared into CCH, prices are soaring again and ease-of-use has fallen by the wayside. The needs of smaller firms and sole practitioners are simply not being met.

To address the problem, I’ve partnered with a group of highly talented tax writers to create Parker Tax Publishing ... a company dedicated to the idea that comprehensive, authoritative tax information service can be both easy-to-use and highly affordable.

Our product, the Parker Tax Pro Library, is breathtaking in its scope. Check out the contents listing to the left to get a sense of all the valuable material you'll have access to when you subscribe.

Or better yet, take a minute to sign yourself up for a free trial, so you can experience first-hand just how easy it is to get results with the Pro Library!

Sincerely,

James Levey

Parker Tax Pro Library - An Affordable Professional Tax Research Solution. www.parkertaxpublishing.com