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Eleventh Circuit: Hobby Losses Are Deductible Only as Miscellaneous Itemized Deductions

(Parker Tax Publishing June 2023)

The Eleventh Circuit held in case of first impression that the deduction under Code Sec. 183(b)(2) for expenses from an activity that is not engaged in for profit are treated as miscellaneous itemized deductions and therefore under Code Sec. 67(a) are deductible only to the extent they exceed two percent of adjusted gross income. Therefore, the court affirmed the Tax Court's holding that none of the expenses taxpayers incurred from chartering a yacht were deductible because they did not exceed the two-percent of adjusted gross income threshold. Gregory v. Comm'r, 2023 PTC 143 (11th Cir. 2023).


In 2011, Carl and Leila Gregory formed CLC Ventures, Ltd., a Cayman Islands corporation, to own and charter a yacht named Lady Leila. Because CLC elected for treatment as a disregarded entity, the Gregorys reported CLC's income and expenses on their personal returns. CLC was not engaged in for profit within the meaning of Code Sec. 183.

The Gregorys filed joint tax returns for 2014 and 2015, reporting CLC's income and expenses on their Schedule C (Profit or Loss from Business). In March 2018, the IRS issued a notice of deficiency to the Gregorys for tax years 2014 and 2015. Because CLC lacked a profit motive, the IRS adjusted the Gregorys' returns, recharacterizing CLC's income as "Other Income" and its expenses as "Itemized Deductions" on the Gregorys' Schedule A. The IRS further classified the itemized deductions as miscellaneous itemized deductions, meaning they were allowable only to the extent that they exceeded two percent of the Gregorys' adjusted gross income under Code Sec, 67(a).

The Gregorys took their case to the Tax Court, arguing that hobby expenses under Code Sec. 183(b)(2) are not miscellaneous itemized deductions subject to the two-percent floor imposed by Code Sec. 67(a). The Tax Court disagreed, determining that the Code's plain language and statutory scheme confirmed that Code Sec. 183(b)(2) grants a miscellaneous itemized deduction. The Gregorys appealed to the Eleventh Circuit.

Code Sec. 183(a) prohibits all hobby loss deductions except for those allowable in Code Sec. 183(b). Code Sec. 183(b)(1) grants activities not engaged in for profit (e.g., hobbies) the same deductions "allowable under this chapter...without regard to whether or not such activity is engaged in for profit." Code Sec. 183(b)(2) allows "a deduction equal to the amount of the deductions ... allowable under this chapter ... only if such activity were engaged in for profit." However, Code Sec. 183(b)(1) provides that the amount of this deduction cannot exceed the difference between the hobby's gross income and the deductions allowed under Code Sec. 183(b)(1).

During the relevant time period, Code Sec. 67(a) allowed a taxpayer to deduct miscellaneous itemized deductions only to the extent that the aggregate of such deductions exceeded two percent of adjusted gross income. In other words, a taxpayer could deduct only the portion of miscellaneous itemized deductions that surpassed two percent of the taxpayer's adjusted gross income. This two-percent floor rendered miscellaneous itemized deductions of little value to most taxpayers.

Observation: In the Tax Cuts and Jobs Act of 2017, Congress enacted Code Sec. 67(g) to disallow all miscellaneous itemized deductions of whatever amount. This provision is set to sunset in 2025.

Before the Eleventh Circuit, the Gregorys argued that Code Sec. 183(b)(2) provides a "deduction framework" that requires hobby losses to be treated the same as business expenses in all respects. They reasoned that because Code Sec. 183(b)(2) waives the for-profit requirement for other deductions in the Code, Code Sec. 183(b)(2) deductions receive the same placement as trade and business deductions on a taxpayer's return. If the Gregorys had conducted their chartering activities for profit, they could have deducted trade and business expenses from Lady Leila under Code Sec. 162 and placed that deduction above the line under Section 62(a). The Gregorys therefore reasoned that their Code Sec. 183(b)(2) expenses attributable to Lady Leila were deductible above the line just as if they were trade or business expenses. The Gregorys further argued that, because Code Sec. 183(b)(2) caps the deduction amount at the hobby's gross income minus the Code Sec. 183(b)(1) deductions, Code Sec. 183(b)(2) expenses must reduce a taxpayer's gross income - not the taxpayer's adjusted gross income - and therefore belong above the line.


The Eleventh Circuit agreed with the Tax Court that Code Sec. 183(b)(2) expenses are below-the-line miscellaneous itemized deductions. Further, since the Gregorys could not meet the two-percent threshold for miscellaneous itemized deductions, the court held that their expenses from operating Lady Leila were not deductible.

The court noted that Code Sec. 183 does not expressly address how a Code Sec. 183(b)(2) deduction is treated, so it looked elsewhere in the Code. The court started with Code Sec. 62, which lists all above-the-line deductions that reduce gross income. These deductions include trade or business expenses, losses from the sale or exchange of property, and certain attorney's fees. Nowhere does Code Sec. 62 mention Code Sec. 183 or hobby expenses. According to the court the list in Code Sec. 62(a) is exhaustive, and nothing in the text suggests that Congress hid other above-the-line deductions elsewhere in the Code.

Next, the court noted that the definition of "itemized deductions" in Code Sec. 63(d) means all deductions except (1) the above-the-line deductions listed in Code Sec. 62 and (2) any deduction referred to in any paragraph of Code Sec. 63(b). Code Sec. 63(b) lists four deductions: the standard deduction, the personal exemption deduction under Code Sec. 151, the qualified business income deduction under Code Sec. 199A, and the charitable contribution deduction under Code Sec. 170(p). Again, Code Sec. 183 is nowhere to be found. The court found that the Code Sec. 183 deduction must therefore be an "itemized deduction."

Last, the court looked at Code Sec. 67. Code Sec. 67(a) imposes the two-percent floor on miscellaneous itemized deductions. Code Sec. 67(b) defines "miscellaneous itemized deductions" as all "itemized deductions" other than twelve specific listed deductions, none of which mentions hobby expenses or Code Sec. 183. Thus, the court concluded that Code Sec. 183(b)(2) expenses are miscellaneous itemized deductions which under Code Sec. 67(a) are deductible only to the extent that the aggregate of such deductions exceeds two percent of adjusted gross income.

The court rejected the Gregorys' argument that the Code Sec. 183(b)(2) should be given the same priority and placement as the trade or business deduction. The court said that, despite referring to business activities to set the deduction "amount," in no other respect does Code Sec. 183(b)(2) say to treat the deduction the same as a business expense. Responding to the Gregorys' argument that Code Sec. 183(b)(2) expenses must reduce gross income because the statute caps the deduction amount at the hobby's gross income minus the Code Sec. 183(b)(1) deductions, the court pointed out that the Code Sec. 183(b)(2) cap is based on the hobby's gross income, not an individual's overall gross income from whatever source. In the view of the Eleventh Circuit, the Tax Court correctly concluded that Code Sec. 183(b)(2)'s reference to "gross income" merely concerns the maximum allowable deduction amount. It is a benchmark for capping the deduction, the court found, not a command to apply hobby loss deductions against a taxpayer's total gross income.

For a discussion of the application of the hobby loss rule, see Parker Tax ¶97,515. For a discussion of miscellaneous itemized deductions, see Parker Tax ¶85,103.

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.

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