I'm curious as to what happens if an individual has two or more hobby-activities that an individual treats as a business. If two or more activities were to incur losses for a year or more, and for the sake of argument-- simultaneously (as even hobby activities may be affected by recessionary downturns); do such losses from two or more activities produce further scrutiny on part of the IRS?© BrainMass Inc. brainmass.com December 15, 2020, 4:47 pm ad1c9bdddf
Although the IRS does not publicly disclose their specific criteria for audit selection, it has always seemed to me that the amount of business loss disclosed on the face of the Form 1040 is a major part of the criteria. At first glance, it wouldn't matter if there were 3 or 4 businesses in supporting schedules, but the total on the 1040 would appear to determine selection.
It is not uncommon for there to be more than one business (Schedule C) in a tax return. Often each spouse may have separate businesses, or in some states, the same business must be split in two parts if both spouses participate.
For example, let's say you had 3 businesses and 2 of them operated at a profit, but the third showed a loss. It the net income amount of the 3 businesses was a net profit, the likelihood of being audited for any of the three businesses is less than if there was a net loss on the 1040.
That being said, there can be a problem in an audit situation if multiple businesses show a loss. Using any of the 9 explanations below from the regulations, an auditor could say that (3) there is insufficient time and effort expended by the taxpayer in carrying on the activity, for example. An auditor may state that with a real job and another business, the loss is more likely a hobby loss. The same auditor could complain about (1) below following the same reasoning.
As your comment about economic downturns, the auditor might discuss (6) below. If there was a history of a profitable business, a defense about the current economy would probably be sustainable.
Another tactic the IRS has at its disposal for certain situations is to resolve the audit by leaving it open for a five year period. A taxpayer expects to have profits 3 years out of 5 even though this is year 2 and shows a loss. The auditor will revisit the audit by examining future tax returns for profits as expected by the taxpayer. If the subsequent years are also losses, then all years can be denied. If the subsequent years are indeed profits, then the losses in year 1 and 2 will be allowed. This is a more drastic step, but I have used it in the past.
Sec 1.183 - Hobby ...
The 1460 word solution answers the questions posed in the problem, but also includes good details about facts used by the IRS to define and distinguish hobby losses from business activity.