I want to take a look at a court case with you. This case doesn't have to do with a travel agent specifically, but does have to do with an individual operating as a travel blogger. This case helps us understand what the IRS and tax court are looking at when it comes to operating a business as a hobby or as a business. As we go through the case, you are likely going to think to yourself, well duh, that doesn’t work or you obviously can't do that or this is an extreme case. And while I agree with you, we can always use some of the information from these cases to learn how the IRS and tax court thinks, what mistakes others have made and what we can do to avoid those mistakes in the future.
So let’s jump right in and take a look.
The court case was JOSHUA W. PINGEL (the blogger / writer), v. COMMISSIONER OF INTERNAL REVENUE (the IRS). You can check out the actual court opinion in the link below.
The case took place in 2015 where the IRS determined that Joshua owed $7,147 in federal income tax and that he was liable for $1,429 in penalties for the tax return he filed in 2008. The issues in this case support whether or not he was engaged in the business of “travel guide writer” for profit and if he should be able to deduct his travel and other expenses as a business expense. The IRS thinks NO, Joshua the blogger / writer thinks YES.
Now if you review the court case, you will see that originally, the IRS was only looking at the travel expenses and whether or not they were business expenses. This somehow changed to whether or not he was engaged in his activity for profit. Essentially, was he operating as a hobby or a business. If you don't understand why this matters, check out this IRS resource or take the first lesson in my Taxes for Travel Agents Course for FREE.
Background
All of this started in 2007 when Joshua took a trip to Australia. During this 10-day trip, he decided that he wanted to pursue travel as a career. In December of 2007, after returning from his trip to Australia, he started setting up his future travel business which he hoped would be an exciting and profitable career as a travel guide writer. He set up Virgin Backpacking, LLC (LLC), as a Colorado LLC and obtained an EIN for the LLC from the IRS.
His plan was to travel the world, write a blog about his travels, and make money through affiliate links in his blog posts. In addition, he was going to write and sell books related to his travels around the world.
In 2008, he quit his jobs as a Senior Client Relationship Manager, took a distribution from his 401k of $43,891 and started his journey. Over the next 5 ½ months he traveled throughout Europe, Africa and the Middle East.
I'm not gonna lie, this sounds like an epic adventure. While I am the last person to tell you to liquidate your 401k (because you pay income tax and penalties on that money, not to mention the compound growth you will miss out on) and travel the world in an effort to build a profitable business, I definitely applaud his courage and optimism if that’s what we are gonna call it. It is true that you only live once (YOLO), but you might live a long time. So always live for today but be sure to plan for tomorrow. Let’s continue.
During his travels, he updated his blog with pictures and captions. While he did include details about some of the sites he saw, places he stayed, and food he ate, he didn't provide enough information for the reader to find the location, any affiliated links, partnerships, advertisements or other ways that he could actually generate income. He did keep all his receipts from everything he did but didn't document much if anything as to the business purpose for each expense.
During his travels, and after returning from the 5 ½ month trip he realized that the market was saturated with travel blogs and that his plan for generating income through affiliate sales was not going to be profitable. He decided to shift his focus to writing books about his travels.
Joshua wrote 3 books after returning from his travels. At the time of this court case (7 years after his travels), 2 were complete and one was in production. However, as of the date of the court case, none of the books had been published or were available for sale. He also could not estimate when the books would be published and available for sale. He had also not earned any income from his books.
Joshua filed his 2008 Federal income tax return and listed "World Travel Guide" as his principal business on the Schedule C, Profit or Loss From Business, attached to the return. On Schedule C, he did not report any business income. He claimed total expenses of and reported a net business loss of $39,138. As part of his net business loss, petitioner claimed deductions for travel expenses of $19,347, deductible meals and entertainment expenses of $6,314, and other expenses of $5,431.
Court’s Rationale
In the opinion of the IRS, he was not engaged in this activity for profit. Generally, the IRS’s determination of a deficiency is assumed to be correct, and you, the taxpayer, bears the burden of proving this to be incorrect. Furthermore, deductions are a matter of legislative grace, and the taxpayer bears the burden of proving his entitlement to any deductions claimed.
Now, Under section 7491(a) the burden of proof may shift to the IRS if the taxpayer produces credible evidence with respect to any relevant factual issue.
Generally, the Internal Revenue Code allows deductions for ordinary and necessary expenses incurred in conducting a trade or business or for the production of income. If an activity is determined to NOT be engaged in for profit, then no deduction for that activity is allowed.
In order to make this determination, the court looks at several things.
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. The 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. Whether elements of personal pleasure or recreation are involved.
The tax court went through and analyzed each of these items. If you want to read about each one, you can check out the court case. However, I am just going to focus on the ones I think are most applicable to travel advisors.
Manner in which the taxpayer carries on the activity
Conducting yourself in a businesslike manner like maintaining complete and accurate books and records may indicate whether you are engaged in the activity for profit. Carrying on the activity in a manner substantially similar to that of other similar activities that are profitable and changing operating methods or adopting new techniques or abandoning unprofitable methods in a manner consistent with an intent to improve profitability may also indicate a profit motive.
While he did set up an LLC, his filings were not up to date at the time of the court case. He also did not maintain any books or records for the activity. He had no written business plan and no estimate as to when his website would be operational, when his books would be published, or when he would begin to earn income from the activity. Although he documented and retained receipts for his travel-related expenses, the tax court said, “merely maintaining receipts is not enough to indicate a profit motive.”
The Court found that the activity was not carried on in a businesslike manner or operated in a manner similar to that of other similar activities, or that he made changes to his operation methods or adopted any new techniques to improve his profitability.
The Taxpayer's History of Income and Losses With Respect to the Activity
If a taxpayer has engaged in an activity for multiple years, "a series of losses during the initial or start-up stage of an activity may not necessarily be an indication that the activity is not engaged in for profit." However, continued sustained losses beyond the initial or startup period required to bring the activity to profitability, if not explainable as "due to customary business risks or reverses" may be indicative of the lack of profit motive. However, "a series of years in which net income was realized would be strong evidence that the activity is engaged in for profit."
Joshua began the activity in 2008 and claimed a business loss of $39,139. The court said that “it is not uncommon to incur losses in the first year of an activity, BUT, there is no evidence in the record, however, that future profits will cover the startup losses.”
Elements of Personal Pleasure or Recreation
The court stated that the presence of personal motives in carrying on an activity may indicate the activity was not engaged in for profit, particularly where there are recreational or personal elements involved. Where there are no elements of personal recreation, the inference is strong that there was a profit motive.
But "an activity will not be treated as not engaged in for profit merely because the taxpayer has purposes or motivations other than solely to make a profit." The fact that the taxpayer enjoyed the activity and derived personal pleasure from engaging in it is not sufficient alone to cause the activity to be classified as not engaged in for profit.
However, in this situation, because he gained substantial personal pleasure and recreation from the activity and readily admitted he enjoyed traveling, regardless of any hardships suffered during his travels. This, in combination with the other factors reviewed by the Court, weighs against him.
Court’s Decision:
After review of the factors and all of the facts and circumstances surrounding the activity, the Court finds that Joshua was not engaged in the activity for profit in 2008. The court decided that Joshua owed $7,147 in federal income tax and that he was liable for $1,429 in penalties for the tax return he filed in 2008.
Lessons Learned for Travel Agents:
So did you learn anything from this court case as a travel agent? I hope so! Here is my take away from this court case.
Operate in a business like manner
If you want the benefits of operating a business such as the ability to deduct business expenses, you need to treat your business like a business. This includes separating your personal and business finances and tracking your income and expenses. These should be the basic starting point for a business. If you are looking for an easy to use online bank for your business, I use BLUEVINE. They are 100% online, free, and have a great interest rate for a checking account. They have been great to me and my wife over the years. If you use this link, I receive a small commission that helps me provide more free content and resources for you.
When it comes to tracking your income and expenses there are so many options. Pick something that is easy to use and that you will stick with. I have a free Google sheet on my website for Free. I also recommend Wave Accounting which has both a free and a paid version.
The IRS expects you to be profitable eventually!
The IRS and tax court both agree that losses can be expected in the first year or two of a business. This is very true for travel agents as you typically do not receive a commission until your clients travel. However, the IRS and tax court do expect you to be profitable eventually. This means changing operating methods or adopting new techniques or abandoning unprofitable methods. This could mean less business travel, less conferences, or less of whatever is costing you money and not increasing your income. If you are losing money, you should be putting together a written plan at the beginning of the year documenting what you are going to do differently this year to make you profitable.
Document, Document, Document
I can’t stress this enough. For each expense, you need to document the date, amount, who you paid and THE BUSINESS PURPOSE of that expense. You need to understand what is and is not a deductible business expense and what the rules are surrounding travel. Publication 463 is a great resource for travel expenses as is the taxes for Travel Agents Online Course.
I hope this article was interesting and helpful for you as a travel agent. What did you take away from this? What lessons did you learn? Let me know in the comments.
Andrew Roed, EA
Taxes For Travel Agents, LLC