Did years of losses make a professional bass-fishing operation a nonbusiness hobby for Virginia income-tax purposes?

Subject

Professional bass-fishing activity was conducted for profit despite continuing losses

Plain-English summary

Virginia found that the husband's professional bass-fishing activity was conducted for profit and abated the 2004 through 2006 assessments. The business had operated since 2002 without a profit, and both spouses earned substantial income from unrelated full-time jobs. Those facts weighed against the claim but did not decide it.

The profit-motive test considered all facts and circumstances. The husband had more than 25 years of tournament experience, attended and presented at fishing events, led a bass club, and regularly competed against other tournament fishermen. His long-term employment also gave him flexibility to devote free time and energy to the business.

The couple produced records sufficient to determine business income and expenses, even without a separate checking account. The husband pursued training and licensure, expanded the range of services and instruction, promoted the operation as a professional endeavor, and invested a significant 2005 prize in business assets to reduce dependence on sponsors.

On balance, Virginia found a genuine objective to make a profit. It removed the income-tax and interest assessments for 2004 through 2006.

What this means for you

• Repeated losses do not automatically make an activity a hobby.
• Books, records, expertise, time, changes aimed at revenue, promotion, and reinvestment can show a profit objective.
• Full-time employment and substantial outside income are relevant but not conclusive.
• Personal pleasure from an activity is only one factor in the overall federal analysis.

Common questions

Did the business earn a profit during 2004 through 2006?

No, but the ruling found the total evidence showed a profit objective.

Was a separate business bank account required for relief?

No. The records were still sufficient to identify income and expenses.

What happened to the assessments?

Virginia abated the income tax and interest for all three years.

Citations and references

• Va. Code §§ 58.1-219, 58.1-301, and 58.1-322.
• IRC § 183.
• Treas. Reg. § 1.183-2(b).

Source

• Landing page: Virginia Laws, Rules & Decisions
• Ruling: P.D. 10-79

Original ruling text

May 18, 2010

Re: § 58.1-1821 Application: Individual Income Tax

Dear *:

This will reply to your letter in which you seek correction of the individual income tax assessments issued to * (the "Taxpayers") for the taxable years ended December 31, 2004 through 2006. I apologize for the delay in responding to your letter.

FACTS

The Taxpayers, a husband and wife, are Virginia residents who were employed full-time during the taxable years at issue. The husband also operated * (the "Business"). The Taxpayers reported losses from the Business on federal form Schedule C, which passed through federal adjusted gross income (FAGI) to their Virginia returns.

The Business was started in order for the husband to pursue professional bass fishing. Professional bass fishing is a small but growing sport, in which a single prize can fund a business for a number of years and can result in sponsorships. The husband has placed well in a significant number of tournaments.

Under audit, the Department found that the Business had operated continuously since 2002, without making a profit. The auditor concluded that because the Business had not made a profit and did not meet some of the factors listed in Treas. Reg. § 1.183-2(b), it was not engaged in for profit. As a result, the Department issued assessments for the 2004 and 2005 taxable years. In addition, the Department withheld a portion of the refund requested by the Taxpayers on their 2006 individual income tax return. The Taxpayers appeal the assessments, contending that the Business was engaged in to make a profit.

DETERMINATION

Virginia Code § 58.1-301 provides that terminology and references used in Title 58.1 of the Code of Virginia will have the same meaning as provided in the Internal Revenue Code (IRC) unless a different meaning is clearly required. For individual income tax purposes, Virginia "conforms" to federal law, in that it starts the computation of Virginia taxable income with FAGI. Income included in the FAGI of a Virginia resident is subject to taxation by Virginia, unless it is specifically exempt as a Virginia modification pursuant to Va. Code § 58.1-322.

As a general rule, the Department relies on the accuracy of information and computations reflected on the federal income tax return when reviewing Virginia individual income tax returns. If the information provided on the federal return looks reasonable, there is generally no reason to look behind those computations. However, the Department retains the authority to adjust FAGI where there is clear evidence that the amounts reported on the federal or Virginia income tax return are not consistent with the Internal Revenue Code (IRC). See Va. Code § 58.1-219.

Under IRC § 183, deductions can be disallowed for activities not engaged in for profit to the extent that the expenses exceed income generated by the activities. The determination whether an activity is engaged in for profit is determined by taking into account all of the facts and circumstances of each case. Taxpayers must have the objective of making a profit.

Treas. Reg. § 1.183 2(b) identifies nine factors that should be taken into account when determining whether an activity has a profit motive: (1) The manner in which the taxpayer carries on the activity; (2) the expertise of the taxpayer or his advisors; (3) the time and effort expended by the taxpayer in carrying on the activity; (4) 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, which are earned; (8) the financial status of the taxpayer; and (9) elements of personal pleasure or recreation.

The federal regulation makes it clear that all facts and circumstances must be considered in determining if an activity is engaged in for profit. The regulation further states no one factor is determinative, and consideration is not necessarily limited to these nine factors.

The husband had developed significant knowledge of fishing-related activities. He has participated in bass tournaments for more than 25 years and attended numerous fishing shows, meetings and seminars related to fishing. He has been a speaker or presenter at a number of these shows. He has also been the president of a bass club. Further, he has regularly tested his fishing skills against other tournament fishermen.

The evidence also shows that the Taxpayers were both employed full-time in activities unrelated to the Business and had substantial income from sources other than the Business. In contrast, the nature of the husband's employment and longevity of his career with the same employer afforded him significant flexibility to adjust his work schedule to meet the time requirements of the Business. Although he was not prepared to leave his employment for an activity that had no guarantee of success, he consistently devoted free time and energy to the activity.

Although the Business did not make a profit during the 2004 through 2006 taxable years, significant documentation has been provided with regard to those activities. The manner in which a taxpayer carries on the activity is one factor to consider in determine whether a profit objective exists. Maintaining complete and accurate books and records is indicative of activities carried on for profit. Although the Taxpayer did not maintain a separate checking account for the Business, the books and records were sufficient to determine the income and expenses associated with operation of the Business.

In addition, recognizing the need for a more consistent revenue stream, the husband has expanded the range of services offered by the Business. To that end, he obtained training and licensure for himself as well as for the Business. As a result, he is now a licensed captain and the Business has expanded its operations and is not licensed to conduct chartered fishing guide trips. In addition, the Business now offers an array of instructional training and sponsors an annual family day with fishing centric activities. The Business has also taken consistent steps through the years to promote itself as a professional endeavor and to build upon that reputation.

In addition, the husband has made investment decisions aimed at perpetuating the Business and enhancing future profitability. After winning a significant prize in 2005, the husband invested in assets for the Business in order to make it be less reliant on sponsors for its operation in tournaments.

After weighing all the facts and circumstances in this case, including the Taxpayers' other sources of income for the taxable years at issue, I must conclude that the preponderance of the evidence supports a finding that the husband did conduct the Business for the purpose of making a profit. As such, the assessments of income tax and interest for the 2004 through 2006 taxable years have been abated.

The Code of Virginia sections cited are available on line at www.tax.virginia.gov in the Tax Policy Library section of the Department's web site. If you have any questions regarding this determination, you may contact * in the Office of Tax Policy, Appeals and Rulings, at ***.

Sincerely,

Janie E. Bowen

Tax Commissioner

AR/1-2329090220.E