Let’s say
that we work together. I cannot attend an appointment with a new client first
thing in the morning. You volunteer to cover for me.
By the way,
welcome to tax practice. Believe me, it is not the glitz and glamour that
Hollywood makes it out to be. I know: hard to believe.
You meet the
Fishers. They are both attorneys, he as partner in a firm and she as a sole
practitioner. They have three children, all under the age of 10. She takes her
kids to work periodically for the customary reason: the cost of day care and
family members unable to care for the kids at the time.
She had an
opportunity to represent a client in the Czech Republic for a few weeks, and she
took it. It turned out however that he was unable to watch the kids. Seeing
herself in a jam, she took the kids with her but came up with a novel twist:
She would write a travel book about the Czech Republic. It
would be written to and for kids and would lessen their tedium while travelling.
She had no
previous writing experience, so this was new territory. It occurred to her that
other parents might be interested in such books – and this could be a business
opportunity for a sharp and motivated person.
She has kept
this up now for three years. She has now taken the kids to Disney World as well
as to several cities in Europe.
You talk to
her about the IRS and its “hobby loss” rules. She is an attorney, not a writer;
there is a gigantic personal enjoyment factor present, ….
She cuts you
off. Remember: she is an attorney. She has read up on this area of tax law, and
she thinks she meets the requirements. For example,
·
She
consulted with one of her clients, a published author, who gave her advice on
both writing and publishing.
·
That
person introduced her to a book distributor, who suggested she hire a graphic
designer. She did so.
·
She
also consulted with a friend who works at HarperCollins; the friend recommended
she hire an agent. She has not done that yet.
·
She
completed four prototype books, but has not submitted them for publication. She
has instead self-published. Sales however have been minimal.
The Fishers need
to file returns for the last three years. Her combined loss from the book-writing
activity is approximately $75,000.
They ask
whether you can prepare their returns and claim the book-writing loss.
What do you say?
The big
issue is whether the activity rises to the level of a tax deduction. You
remember some of the factors that the IRS uses to identify a hobby:
·
Not
run in a business-like fashion
·
Failure
to consult experts
·
Failure
to revise business plans when losses pile up
·
Profits
dwarfed by the losses
But Ms.
Fisher has been meeting people. She has made contacts at a publishing house.
She has written prototypes. She has self-published. She seems to be getting
some things right.
You don’t
see a clear-cut answer. Two people can reasonably disagree. The problem of
course is that the IRS has a bit more horsepower than the average person you
might disagree with.
You wobble.
You tell them that you want to review the literature in this area, as the issue
is walking the grey lands. You will call them tomorrow.
We have a
chance to talk about the meeting.
I see two
things immediately:
(1) Can we prepare and sign the return
under professional standards?
(2) If so, there is still a significant
chance that they would lose the deduction on audit.
Professional
standards allow a tax practitioner some leeway when confronted with certain issues.
This is fortunate, or professional practice would likely grind to a near halt. The bar can be higher or lower depending upon
the particular issue under discussion. Take a “listed transaction,” for
example, and the bar is pretty high. Listed transaction is jargon for tax
shelter, and we are nowhere near that with the Fishers. Our bar is much lower.
However, I
would say our best chance with the IRS is 50:50, and likely less than that. We would discuss this with the client and
allow them to decide. It is their return, after all. Maybe they will get
another accountant’s opinion. Maybe I am wrong.
This is a
real case, by the way.
The Fishers
are from New York and took this issue to Tax Court.
They lost.
The Court
decided that her activity was not so much a business as her investigating going
into business. The Court pointed out a few things: she had not hired an agent,
had not finalized a book, and had not submitted a proposal to a publishing
house. Since business activity had not started, it did not have to consider
whether the activity was a hobby.
No business
activity = no business deduction.
What do I
think?
The Court
saw too much personal and not enough business. I suppose that had she been
making money the Court may have relented. She had to clear the hurdle of
deducting what many people would see as vacations, and that required some
serious weight on the other end of the see-saw to sway the Court.
