Race Car Winnings

[Snaggletooth]

The South is full of dirt car tracks, erstwhile low rent race tracks, and Richard Petty wanna-bes.

I have a client who works a "day" job, and races 25 times a year. In 2007, he asked about filing a business loss. He said he won some $3000, and we sat down to compute his expenses. He had depreciation, repairs, etc. of some $9000 and this was only the first year of MACRS depreciation. In 2008 the depreciation would nearly double.

I summarily dismissed the idea of reporting a loss for an activity which had no realistic hope of ever turning a profit. A typical "hobby." So we did nothing.

Turns out the Racetrack gave him a 1099 for some $2800 for 2007, and of course the IRS sent him a CP2000 asking him for appx $1200. Right or wrong, it got our attention. He didn't tell me he received a 1099, but he DID tell me he won appx $3000.

The old-fashioned knee-jerk is to prepare a Sch. C with $2800 in revenue and $2800 in expense.

But now I look in the Tax Book for Hobby Reporting (p. 5-20), and find out the $2800 goes on line 21. There are no property tax, interest, or other "mainstream" schedule A deductions, so that means whatever expenses are associated with the racing are reported as "Misc Itemized Deductions" subject to the 2% floor. What's worse, the dollar amount of the expenses have to be factored down such that they do not exceed $2800.

Guess what? Guy lives in his deceased mother's old farmhouse, with property taxes of $300/yr, some $1000 in sales tax deduction, no income tax in Tennessee, and no mortgage interest.

Yep. This guy's expenses are sucked into a Schedule A that doesn't exceed the standard deduction. And the $2800 on Line 21 becomes entirely taxable.

This doesn't seem right. Have I misread or misunderstood something??

Thanks in advance for your help or comments.

[geekgirldany]

How long has he been racing? Might could apply the 3 out of 5 year rule. After that a hobby rules? I am just thinking out loud here. I would be hesitant to say it was a business also.

[OtisMozzetti]

Thanks in advance for your help or comments.

I say roll up your sleeves and see whether the 9 factors of hobby vs. business can be used to show that he has been behaving with a profit motive.

[RLymanC]

I agree with Otis

There are thousands of businesses that loose money. I would venture to say 99.9% of them loose money in the first year.

[AuditorTurnedGood]

I audited a taxpayer very much like this guy

The taxpayer had a full time, 40 hour a week job at a local chemical maufacturer. He had a race car, raced nearly every weekend, and spent evenings working on his car. He won a little money here and there, but for the most part just burned through cash. No profit motive, no plan to become profitable besides "win more races", signifigant personal pleasure, spotty, small winnings, never run a business, etc, and bad record keeping to boot. It was all over before we started.

I put the income on 21 and the expenses on Other Misc on A. He was an itemizer, but the 2% floor wiped him out.

I think you're right.

ATG

[Nashville]

Atg

Auditor-turned-good, thanks for addressing the original question. GeekGirl, Otis, and Lyman had very relevant posts, but for purpose of addressing the mechanics of hobby reporting, it was determined up front that the driver had a hobby and not a business.

So the guy has to pay extra simply because he can't itemize? By all standards of right and wrong the guy should just be denied the loss and that be the end of it.

[AuditorTurnedGood]

I agree with you nashville, but the more I read about tax code and IRS established positions, the more I realize much of the tax code just doesn't make logical sense.

ATG

[DaveO]

This topic is one that always gets me red in the face. The income belongs on Line 21. On the other hand the IRS asking for $1200 on the $2800 tells me they think the income belongs on a schedule “C”. If they really want a “C” give them one.

I really believe the service should have a box to check on the “C” that indicates a not for profit motive. That way you can correctly report the income and expense with no loss deductible and no SE tax in a profit year.

In the eyes of the IRS if there is a profit it’s a business, if there is a loss it’s a hobby.

[Burke]

I agree with ATG. I had the same case with a client with a full-time job who fished in major tournaments all over the US, and he got 1099's for his prizes. Went on Line 21, and expenses up to income went on Sche A, subj to 2%. Nash, if you itemize for him, does it even come close to the standard? Would it make a difference on the state return to itemize? (Not if he is in TN, I guess). So you can point out to him that he is not really "losing" anything by claiming standard, in fact, he is coming out ahead! And enjoying a hobby for which he sometimes receives money on which he does not have to pay SE tax. Now if he quits his job and goes on the circuit full-time as a pro, you could get away with a Sche C, maybe. My guy tried that too, spent a ton of money and went back to work.

[Jesse]

...........So you can point out to him that he is not really "losing" anything by claiming standard, in fact, he is coming out ahead! And enjoying a hobby for which he sometimes receives money on which he does not have to pay SE tax. .....

I was thinking along the same line........I'd rather not have a house payment, not have 10x $300 property tax bill and Wisconsin's high income tax. But I'm sure that is not really very reassuring for your client.

[geekgirldany]

This race car stuff can get out of hand quickly. Atleast for me it did. Had two customers that did this. One paid for race car parts and engines out of his business account. It was already set up to do this as advertising. I left it as that until the spending got over $5,000. They went to someone else that would prepare it for them.

Had another one that was paying out so much for race expenses. At the time I handled it as a business. I told them to get a business account for the "race team". They had a S-Corp for their "main" business so I told them if they wanted to pay for parts they had to do it out of the racing business account. The S-Corp can pay for sponsorship. The sponsorship money paid to the race team would be reported as income on Schedule C and of course the expenses would be reported.

For whatever reason I got a letter from them that a fellow racer said it could be handled in a way that would allow them a larger deduction and refund at the end of the year. They went to his accountant.

[Nashville]

Whoa!!

So you can point out to him that he is not really "losing" anything by claiming standard, in fact, he is coming out ahead!

Burke, I respect the knowledge that you normally bring to the table, but I really have to take issue with this one. I understand the concept of being able to deduct Schedule A stuff but if you are end up with the std deduction it does you no good. IRS will allow a married couple some $10,900 to deduct even if they are living under a bridge in downtown Detroit.

Yes, you can tell him that your client in Atlanta is paying $7,000 in property taxes, and $15,000 in interest and how lucky he is to be saving all this money by living in a dilapidated farmhouse on Poverty Creek.

Try pointing out why he is having to pay taxes on $2800 when he has actually lost money. Then try to tell him he is allowed to deduct $2800 of his expenses but the deductions disappear into a black hole and only his revenue survives.

It's amazing how quickly these people go to the bottom line and miss the fine art of disciplined tax mechanics in the process. Like the guy in GeekGirl's post after hearing he could get better deductions from his partner's accountant -- "He went to his accountant."

I was hoping there would have been a more benign treatment of Hobby Losses other than treating them as income, but as Bees Knees has remarked, "Who says this stuff is fair or has to make sense?"

[JG EA]

Try pointing out why he is having to pay taxes on $2800 when he has actually lost money. Then try to tell him he is allowed to deduct $2800 of his expenses but the deductions disappear into a black hole and only his revenue survives.

OK, what about COG's to subtract from Line 21. I'm just thinking here. Would repairs and stuff put into the thing that makes it go faster be a COG's and reduce his winnings? Could it be viewed as different than operating expenses for a vehicle that takes you somewhere to do a hobby than the hobby being the vehicle.

[Nashville]

Good Thinking

JG, this idea does have possibilities. After all, "cost" of goods sold can be netted out against the revenue on line 21, and makes for a stronger deduction than anything on a schedule A.

Problem is there are no "goods" being sold. However, IRS requires some overhead costs be inventoriable and they end up as cost of goods sold. I wonder if this opens up some possibilities...

[newbie]

kinda harsh

Wow Nashville, I highly respect the knowledge that you bring to the table as well, but this isn't the only part of the tax code that isn't fair. Why have a standard deduction at all? Let the guy deduct the $300 property taxes, $1000 in sales tax deduction, and the $2,800 hobby loss and call it good. Let the couple living under the bridge deduct nothing, and the guy in Atlanta deduct the $22,000.

If the guy is living in a dilapidated farmhouse on Poverty Creek perhaps he should think twice about spending $9,000 to earn $3,000.