When a “business” isn’t a business and deductions are denied

A recent U.S. Tax Court case highlights a common issue tax professionals see: taxpayers claiming business deductions for activities that never rise to the level of a true business.

In Tracey Yvonne Lucas v. Commissioner T.C. Memo 2026-22, the court denied all Schedule C (Form 1040), Profit or Loss from Business (Sole Proprietorship), deductions and upheld penalties. The reason was straightforward. The activity was not a trade or business, and the expenses were not properly supported.

Analyzing the ruling on Tracey’s TLC

The taxpayer reported a home healthcare activity on Schedule C called “Tracey’s TLC.” She provided care for an acquaintance’s adult daughter several days a week.

However, the financial side told a very different story:

• She received less than $200 per year for her services. 
• She did not charge a set fee. 
• She sometimes received no payment at all. 
• She did not report this income on her tax return. 

At the same time, she claimed thousands of dollars in business expenses, including vehicle costs, utilities and insurance. The IRS disallowed all deductions and assessed penalties. The court agreed.

Why the deductions were denied

The court focused on two key issues: whether the activity was a business and whether the expenses were substantiated. 

1. No profit motive

To deduct expenses under §162, the taxpayer must be engaged in a trade or business. That requires a profit motive.

Here, the court found: 

• She did not operate in a way designed to earn income. 
• Payments were sporadic and minimal. 
• She had no other clients. 

In short, this looked more like a personal arrangement than a business. Without a genuine intent to make a profit, the activity failed the basic test.

2. Not operated in a businesslike manner

Even if there had been some income, the structure of the activity raised concerns:

• No separate bank account 
• No formal books and records 
• No clear pricing or billing method 
• Funds were mixed with personal expenses

Courts anticipate that businesses will conduct their activities in an organized and businesslike manner. That was missing here.

3. Poor recordkeeping and personal expenses

The taxpayer's documentation was also a major problem:

• Bank statements were altered by hand. 
• Personal and “business” expenses were mixed. 
• Gas receipts did not match claimed amounts. 
• No allocation between personal and business use. 

The court noted that many expenses, such as utilities and insurance, were clearly personal. Without proper substantiation, deductions cannot stand.

Penalties applied

The IRS assessed accuracy-related penalties under §6662(a). The court upheld them because:

1. The understatement exceeded $5,000 
2. The taxpayer failed to keep adequate records 
3. There was no reasonable cause defense 

Relying on informal advice from a nonprofessional adviser did not help Tracey’s case. 

What business taxpayers should do differently

This case offers practical guidance for avoiding similar outcomes.

1. Establish a real profit motive. 

Set pricing, bill clients consistently and aim to generate income. A business should not operate at nearly-zero revenue indefinitely.

2.  Treat the activity like a business. 

Maintain separate bank accounts, track income and expenses and follow standard business practices.

3. Keep clean, reliable records.

Use logs, receipts and accounting systems. Avoid mixing personal and business transactions.

4. Separate personal and business use.

Allocate shared expenses, such as utilities or vehicle use, with clear documentation.

5. Report all income.

Even small or irregular payments must be reported. 

Things to consider 

This case is a reminder that deductions are not automatic. They depend on both the nature of the activity and the quality of the records.

For tax professionals, the lesson is clear: when income is minimal and structure is lacking, the IRS and the court will question whether a business exists at all. Helping clients build proper systems early can prevent costly adjustments and penalties later.