Can Side Hustle Tax Deductions Trigger an IRS Problem?

How Side Hustle Tax Deductions Ended Up in Tax Court

A recent United States Tax Court decision involved a taxpayer who maintained a regular full-time job while operating several side-business activities.

Those activities included private transportation services, event-ticket resale, and efforts to develop a social-media business.

The taxpayer reported the business activities on Schedule C . Sole proprietors generally use Schedule C to report income or loss from a business.

The IRS challenged multiple deductions for three tax years and originally determined significant tax deficiencies and accuracy-related penalties.

The court later allowed some disputed items, so the final amounts required recalculation.

That distinction matters.

The taxpayer did not lose every issue. The court reviewed the disputed items individually and allowed some while rejecting others.

What Did the Taxpayer Try to Deduct?

Many of the taxpayer's expenses will sound familiar to people with side businesses.

They included:

• Vehicle expenses
• Tolls and parking
• Credit-card processing fees
• Phone service
• Phone equipment
• Television and streaming subscriptions
• Marketing expenses
• Event-related costs
• Tickets purchased for resale
• Payments to relatives who occasionally helped with transportation work

Some of the more unusual disputed costs involved access to entertainment events, meet-and-greet experiences, personalized media, and opportunities to interact with public figures.

The taxpayer photographed or recorded some of these experiences and later posted the content on social media.

Some event-related payments had originally been reported as charitable contributions.

During the case, the taxpayer argued that they should instead be treated as marketing expenses connected with the social-media activity.

The court was not persuaded.

Posting It Online Does Not Automatically Make It Marketing

The issue was not whether the taxpayer posted the experiences online.

The taxpayer did.

The court also acknowledged that some posts could have increased views, followers, or public attention.

The important question was whether the expenses were primarily undertaken for business rather than personal reasons.

The court concluded that the particular entertainment experiences at issue were mainly personal.

Posting about them later did not automatically transform them into deductible marketing expenses.

The court did not establish a rule that influencers or content creators can never deduct event-related costs.

It concluded that this taxpayer did not sufficiently prove that these particular expenses were primarily business expenses.

This lesson reaches beyond entertainment events.

A food creator cannot assume every restaurant meal is deductible because a photo appeared online.

A travel creator cannot automatically deduct every vacation because videos were recorded.

A fitness creator cannot treat every item of clothing as a business expense simply because it appeared in a post.

Similar expenses may qualify in other circumstances.

The result depends on the facts, primary business purpose, and available documentation.

What the Tax Court Allowed

The court allowed several expenses when the taxpayer had enough evidence and a clear business connection.

Vehicle and Transportation Expenses

The taxpayer maintained records showing dates, fares, tolls, starting locations, and ending locations for many transportation trips.

Exact mileage was not recorded for every trip, but available records and mapping information were used to reconstruct some of the mileage.

The court allowed 80% of certain vehicle expenses, tolls, and parking costs.

This result was unusual.

Because the vehicles were used directly to transport people for compensation, a specific statutory exception meant that the normal strict vehicle-substantiation rule did not apply in the same way.

That allowed the court to estimate part of the deductible expense.

The safer approach is to maintain a timely mileage log showing the date, destination, distance, and business purpose of each trip.

Credit-Card Processing Fees

The taxpayer proved that certain processing fees were connected to customer payments for transportation services and ticket sales.

The court allowed those fees as ordinary and necessary business expenses.

The connection was straightforward: customers paid for business services, and payment processors charged fees to handle those transactions.

Part of the Phone Expenses

The court accepted that a phone was needed for the transportation activity because customers used it to schedule pickups and the taxpayer used it for navigation.

However, the taxpayer maintained several phones and did not keep sufficient records showing how each one was divided between business and personal use.

The court allowed 25% of the reported phone-service expenses but denied the claimed phone-equipment expenses.

The 25% figure was an estimate based on the facts of this case.

It is not a standard IRS percentage.

Qualified Business Income Deduction

The court held that Schedule C income from the transportation and ticket-resale businesses qualified for the qualified business income deduction.

The attempted social-media activity was not the basis for that conclusion because it had generated no gross receipts during the tax years involved.

This mixed result is important.

The court did not simply reject the taxpayer's entire side business.

It evaluated the different activities and disputed expenses separately.

What the Tax Court Rejected

Other expenses failed because the taxpayer could not sufficiently establish their business purpose, amount, or connection to an operating business.

Marketing and Event Expenses

The taxpayer claimed substantial amounts for marketing events and payments that had originally been reported as charitable contributions.

The court found that the particular experiences were primarily personal.

It was not enough that some photographs or videos may have generated online attention.

The attempted social-media business had no advertising revenue during the tax years at issue.

The court noted that genuine pre-opening expenses connected with a future business might instead be governed by the startup-cost rules under Section 195.

However, the court did not complete that analysis because the necessary facts and legal arguments had not been sufficiently developed.

It did not rule that all of the taxpayer's event expenses were startup costs.

Streaming and Television Subscriptions

The taxpayer described television and streaming subscriptions as market research.

The court was not convinced that the subscriptions were sufficiently connected to the businesses.

Watching television and online entertainment is also a common personal activity.

General statements about following trends were not enough to establish the required business connection.

This does not mean a streaming subscription can never be deductible.

It means calling a subscription "research" may not be enough when significant personal use is also present.

Payments to Relatives

Two relatives occasionally helped with transportation work.

The court appeared to accept that some payments were made, but the taxpayer did not provide sufficient records showing the amounts.

The testimony was also not specific enough for the court to make a reasonable estimate.

The deductions failed because of missing proof, not simply because the workers were relatives.

Payments to family members may be deductible when they perform real services and the payments are properly documented.

Useful records can include:

• Duties performed
• Dates worked
• Payment amounts
• Payment records
• Required employment or information-reporting forms

Ticket Costs

For one of the tax years, the taxpayer claimed $730 as the cost of tickets allegedly purchased for resale.

Bank statements showed purchases from ticket vendors, but the taxpayer did not prove that the particular tickets were actually resold.

The court therefore denied the claimed cost of goods sold.

This is another example of why proof of payment may not be enough.

The business connection also needs support.

General Marketing Expenses

The taxpayer relied on bank and credit-card transactions to support additional marketing costs.

Many of the entries contained unclear merchant descriptions and did not show what had actually been purchased.

The statements proved that money changed hands.

They did not establish what was purchased or why the expense belonged to the business.

The court denied those expenses.

Why Business Expense Records Matter

The IRS recordkeeping guidance says taxpayers must maintain records that support the income and deductions reported on their returns.

A bank statement can prove that you paid someone.

A credit-card statement can show the date and amount.

But those records may not explain what you purchased or why it was a business expense.

Useful records may include:

• Receipts and invoices
• Vendor information
• Descriptions of what was purchased
• Notes explaining the business purpose
• Mileage logs
• Contracts and payment records
• Calendars or appointment records
• Copies of related advertisements or campaigns
• Records showing how shared costs were divided

The IRS also provides business expense resources for taxpayers trying to understand common deduction rules.

The IRS does not require every small business to use one specific bookkeeping program.

Your system does need to clearly show income and expenses.

Be Careful When Personal and Business Expenses Share an Account

The taxpayer used both business and personal accounts for different purchases, and some accounts contained clearly personal spending.

That made it harder to identify which transactions actually belonged to the business.

Using a separate business bank account or credit card can make recordkeeping easier.

It does not automatically make every purchase deductible.

The expense still needs a legitimate business purpose.

If one phone is used for both clients and personal calls, the full bill may not be deductible.

If a vehicle is used for customer trips and personal errands, the business portion needs to be separated and supported.

Creating an LLC does not change these basic rules.

When a Questionable Deduction Becomes an IRS Problem

A questionable deduction does not automatically result in an audit.

If the IRS examines the return, however, it may request records supporting both the amount and the business purpose.

If the documentation is not sufficient, the IRS may disallow the deduction.

That can increase taxable income and create additional tax and interest.

An accuracy-related penalty may also apply in certain situations, including some substantial understatements of income tax.

The penalty is commonly 20% of the portion of the underpayment to which it applies.

The exact result depends on the facts and applicable law.

The taxpayer argued that the returns were prepared with reasonable cause and in good faith.

The court rejected that defense after considering the taxpayer's background, inadequate bookkeeping, and repeated inability to establish what certain expenditures were or why they served a business purpose.

The decision involved civil tax deficiencies and penalties.

It was not a criminal tax-fraud case.

What If These Deductions Are Already on Your Return?

Do not panic and do not immediately amend your return based only on one Tax Court decision.

Start by gathering the records you still have.

Look for:

• Receipts
• Emails
• Calendars
• Mileage information
• Invoices
• Contracts
• Copies of advertisements or content connected with the expenses

Then review each expense honestly:

• What did you purchase?
• Who used it?
• Why did you buy it?
• Was the main purpose business or personal?
• Can you support the amount?
• Did you remove the personal portion?
• Was the business already operating?

An amended return may be appropriate in some situations.

In others, the original position may still be supportable with better documentation.

A qualified professional should review the complete return before recommending a change.

If the IRS has already contacted you, pay attention to the response deadline.

The notice may identify the particular expenses and records the examiner wants to review.

IRSProb provides IRS audit assistance for taxpayers who need help reviewing notices, organizing records, communicating with the IRS, or responding to proposed adjustments.

What to Do Next

The lesson from this Tax Court decision is not that side-hustle owners should be afraid to claim legitimate expenses.

The lesson is that each deduction needs a real foundation.

Keep personal and business transactions separate when practical.

Record the business purpose when an expense occurs.

Save documents showing what you purchased.

If an expense serves both personal and business purposes, use a reasonable method to divide it and keep an explanation of how you calculated the business portion.

If you have received an audit notice or believe unsupported deductions may be creating a problem, review the facts before responding.

IRSProb helps taxpayers address audits, disputed deductions, penalties, and other IRS problems. Visit IRSProb to discuss your situation.

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