The hobby-activity category is one of the most undesirable places for your taxable income and deductions. Here are the bad things that happen to your taxes when you have a hobby:

Net hobby income is taxable.

Hobby losses are not deductible.

Whether you have income or losses, you will probably have some hobby expenses that you can deduct. Those deductions are reported as miscellaneous itemized deductions subject to the 2% of adjusted gross income phaseout.

Hobby expenses that survive the 2% phaseout face a second phaseout that applies to select itemized deductions when you report adjusted gross income exceeding $150,500.

If you are subject to the alternative minimum tax, your hobby expenses flat-out disappear, and you get zero benefit from your deductions.

The bottom line: This is one of the most punishing categories in the tax law. Your hobby income can be taxed in the same year that your deductions completely disappear. In years when you have losses, your losses are not deductible. That’s bad! To make matters worse, tax law then attacks any deductions you were allowed (up to the amount of your income) by subjecting them to the damages inflicted by the miscellaneous itemized deduction category, including the possible total loss of those deductions to the alternative minimum tax.

We are going to help you avoid these problems. First, take a second to thank Elizabeth Giles, a dentist, who in the past two years took her horse activity to court in two separate and distinct actions. She lost both court cases;1 however, her loss is your gain, as the second case (2006) provides needed guidelines for making a horse activity—or other hobby—a business.

Let’s look at how the hobby rules took money ... Log in to view full article.