If you are claiming some winnings as 1099 income you can safely claim all direct expenses against those winnings for close to zero tax liability. When you try to claim indirect expenses above your winnings is when it gets tricky.
The IRS allows deductions for net losses for racing expenses only if you can prove it is not a hobby.
There are specific guidelines you must need to prove you are actually running it as a business and not a hobby.
1. Whether you carry on the activity in a businesslike manner. You must run it like a business and show an intent to make a profit. Keeping full and accurate records of all aspects of your business is critical.
2. Whether the time and effort you put into the activity indicate you intend to make it profitable. Put in lots of documented hours if you don't want to be classified as a hobby.
3. Whether you are depending on income from the activity for your livelihood. (guys like Dan Fletcher and the Richardsons, don’t have regular jobs, racing is their job) If you derive more than about {70%} of your income from other sources, it is a hobby according to the IRS, and you can only net your racing expenses against race winnings.
4. Whether your losses are due to circumstances beyond your control or are normal in the start-up phase of your type of business.
5. Whether you change your methods of operation in an attempt to improve profitability.
6. Whether you or advisors, have the knowledge needed to carry on the activity as a successful business. Become an expert and surround yourself with experts. This is more important than you would think, if the IRS thinks that the business is doomed from the beginning, they will disallow your deductions retroactively and hit you with a back tax bill.
7. Whether you were successful in making a profit in similar activities in the past. If this is your first time in a racing business, they will look at your past business experiences.
8. Whether the activity makes a profit in some years, and how much profit it makes.
9. Whether you can expect to make a future profit from the appreciation of the assets used in the activity. If this is a money loser forever it is a tax shelter not a business. Once your enterprise is classified as a tax shelter, even some tax lawyers will shy away from dealing with your case before the IRS.
10. Whether you can really earn a living at racing. Save all of your paperwork including promo flyers. If you entered a $ payout race, document it. If you don’t make money you need to show that you had a realistic potential to make money. (i.e. entered million dollar bracket race, potential to win $300,000 (flyer attached) , netted $3,000 profit/loss between purse and expenses, but could have made $200,000 profit)
To avoid automatically being classified as a hobby, you must show a profit in at least 2 out of every 7 years. If you don't you are sure to be audited and will likely have to spend lots of money on a tax lawyer to defend your claim of being a business. The IRS doesn't want you to use racing as a tax shelter. If you are classified as a hobby you can only deduct expenses or losses from the hobby income, not your regular job's salary.
Another red flag to avoid is mixing your racing business with pleasure. DO NOT combine your trip to the world street nationals in orlando with a trip to Disneyworld with your family. There is nothing illegal about writing off racing expenses, but keep the business aspects clearly separated and well documented.
Hope this helps,
Dan