To File or Not To File

[jwpinkney]

I am filing on behalf of my daughter.  She had a T-shirt business which showed a loss on the 2020 and 2021 1040s.  2022  will be the third year with no profit, so she is subject to the IRS declaring this as a hobby.  In 2020 and 2021, she had W2 and/or 1099 income that made it advantageous to file.  In 2022, she had no income, so technically she should not have to file.  Should she file 2022 anyway, given the earlier tax benefit generated by the business?  If the IRS were to declare the business as a hobby, what actions could I expect?

[AmyC · Accepted solution]

If the T shirt business was reported on her personal return, it may not be necessary.  Sch C businesses are constantly changing so dropping it would have no effect. However, the filing requirement are based on the gross income, not the net. Please see Who Should File a Tax Return for your situation.

If the IRS later decides the business was a hobby, then expenses would be disallowed with a tax due on the new income.

[jwpinkney]

This was a Schedule C business.  If the IRS disallows it, will they send us a bill with what they say is the amount owed, or do I have to file an amended return incorporating the change?

[JamesG1]

Suppose that for one year, the Schedule C in question reported income of $5,000, ordinary and necessary expenses of $5,500 and a Schedule C loss of $500.

If, after review, the IRS viewed the income as hobby income, the IRS would report the $5,000 in income as other income and no expenses would be allowed to be reported against the income.  

So one tax year would lose the $500 loss and an additional $5,000 in taxable income would be added to the tax return.  Penalties could be added.  Interest certainly would be added.

The tax return would be reviewed by the IRS and, after examination, would 'correct' the tax return.  You are correct.  They would send a bill.  You would not be amending the tax return.

@jwpinkney