The Supreme Court’s 2024 decision in Loper Bright Enterprises v. Raimondo effectively overturned the Chevron deference doctrine, significantly impacting how all federal agency regulations, including those related to the “hobby loss” rules (Internal Revenue Code Section 183), are challenged in court. Courts now use their own independent judgment to interpret tax statutes rather than deferring to the IRS’s interpretation, a shift that is already influencing Tax Court cases.
Hobby Loss Regulations
The “hobby loss” rules, primarily found in IRC Section 183 and associated Treasury Regulations (Treas. Reg. §§ 1.183-1 and 1.183-2), determine whether an activity is a hobby (not for profit) or a business (for profit).
- Key Consideration: The IRS’s primary consideration is whether the taxpayer intends to make a profit.
- Presumption of Profit Motive: An activity is generally presumed to be for profit if it generates gross income exceeding deductions in three or more of five consecutive taxable years.
- Consequences: Losses from a hobby cannot be used to offset other income.
- Tax Cuts and Jobs Act (TCJA): For tax years 2018 through 2025, the TCJA suspended miscellaneous itemized deductions subject to the 2% floor, which included hobby expenses deductible against hobby income. This means most hobby expenses are currently not deductible.
The Impact of Overturning Chevron Deference
Historically, under the Chevron doctrine, courts were required to uphold an agency’s (like the IRS’s) reasonable interpretation of an ambiguous statute, even if the court found a different interpretation to be better. The Supreme Court, in Mayo Foundation, explicitly applied Chevron deference to Treasury regulations.
The overturning of Chevron in Loper Bright has changed this dynamic:
- Independent Judicial Review: Courts no longer defer to an agency’s interpretation of the law. Instead, judges now “use every tool at their disposal to determine the best reading” of the statute using their own independent judgment.
- Increased Scrutiny of Regulations: IRS and Treasury regulations face a higher likelihood of being challenged and struck down if a court determines the agency’s interpretation is not the “best” reading of the statute, regardless of its “reasonableness”.
- Impact on Hobby Loss Cases: The shift has immediately appeared in the Tax Court. In cases like Schwarz v. Commissioner, petitioners have challenged the validity of long-standing Treasury regulations related to the hobby loss rules in a post-Chevron environment, arguing the court should not be bound by prior deference.
- Shift to Skidmore Deference: While mandatory Chevron deference is gone, courts may still give Skidmore “respect” to an agency’s well-reasoned and persuasive interpretation, though this is a much less stringent standard.
In essence, taxpayers now have a stronger position to challenge the specific regulations and interpretations the IRS uses to apply the hobby loss rules.