Allan Rolnick, CPA
Today’s millennials and Generation Z have hit some speed bumps on their path toward financial independence—the dotcom crash of 1999, the Great Recession of 2007-08, and the Covid pandemic among them. Many seek whatever security they can find in traditional employment, then launch a side gig. Some of those side gigs feel a lot like work, like delivering for Instacart, recharging electric scooters, or renting rooms on Airbnb. Others are creative and fun, like starting travel blogs, creating online courses, or becoming online influencers, whatever that means. The baby boomers and Gen Xers running the IRS are perfectly happy to share their success in the form of taxes on their profits. That means a generation of Americans who can still remember asking themselves, “Who’s FICA?” when they got their first paycheck is now asking themselves, “What’s a 1099?” But sometimes, a side hustle suffers a “failure to launch.” That’s when taxpayers discover Uncle Sam isn’t nearly as willing to subsidize the losses as he is to share the profits. It’s especially true if the side gig involves anything you might do just for fun. The general rule is that if your side business loses money, you can use those losses to offset your salary from The Man. But if your hobby loses money, the “hobby loss” rule limits your deduction to your income from that activity. In other words, heads the IRS wins, tails you lose. (Now you know why Gen Z is so cynical.) The key to using those losses is to prove you started your side hustle with the intent to make a profit. Two recent Tax Court cases show how that necessary motive isn’t always easy to prove. Sherman vs. Commissioner involved an ER physician who moonlights as a guitarist. Dr. Sherman launched a side hustle called Songswell Productions to create music videos.
He didn’t report any income, but deducted $87,674 for equipment, along with $17,084 in other expenses. Judge Courtney Jones may have had a hard time keeping a straight face when she found that Sherman didn’t operate Songswell in a businesslike manner, had no relevant expertise in video production, couldn’t substantiate the time and effort he claimed to devote to the business, and showed no success in similar ventures. Reading between the lines, it was clear she didn’t believe a word Sherman said, and she disallowed every dime of “alleged business expense deductions,” he claimed. (At least he wasn’t claiming losses from a DJing business, which is literally a job that some celebrities can do with one hand while holding a chihuahua in the other.) Swanson v. Commissioner involved a retired bus driver who opened a charter fishing business with his 22-foot boat in Homer, Alaska, 200 miles from his home in Anchorage. His biggest expense was an airplane he bought to shorten his commute— but he never got a pilot’s license to fly customers with him. He kept receipts but then just handed them to his accountant at the end of the year “to figure it out.” (That’s a direct quote from the taxpayer, and it’s also what the writers currently striking in Hollywood call “foreshadowing.”) Tax Court Judge Cary Pugh bought that Swanson knew how to catch a fish. But she wasn’t buying his ability to run a fishing business, and she disallowed his losses exceeding his paltry $7,554 in gross revenue. In Dr. Seuss’s classic Horton Hears a Who, we learn that “a person’s a person no matter how small.” Sadly, the same rule applies to your side hustle. Be sure to call us before you make any business decision so we can help you make the most of it!
Allan J Rolnick is a CPA who has been in practice for over 30 years in Queens, NY. He welcomes your comments and can be reached at 718-896-8715 or at firstname.lastname@example.org.