Final answer:
A taxpayer may owe tax on hobby income even with a loss because the Internal Revenue Code only allows deductions up to the amount of income generated by the hobby and is not applied if the taxpayer does not itemize deductions.
Step-by-step explanation:
It is indeed possible for a taxpayer to have a loss on hobby activities, yet still owe tax on the income associated with those activities. The Internal Revenue Code stipulates that deductions for hobby activities can only be taken to the extent of income produced by the hobby. This means that while individuals can report income from their hobbies on their tax return, they may not deduct expenses that exceed the income generated, preventing them from utilizing a loss from their hobby to offset other income. For example, if a taxpayer earns $1,000 from a hobby but incurs $2,000 in expenses, they can only deduct $1,000. Additionally, if the taxpayer does not itemize deductions because their total deductions, including hobby expenses, do not exceed the standard deduction, they will not benefit from the hobby expenses deduction at all. Consequently, the taxpayer's taxable income includes the hobby income, but not the full extent of the hobby expenses, leading to a taxable situation even if the hobby operates at a loss.