The COVID pandemic impacted just about every business in the U.S. Right or wrong, Congress acted to prevent the financial fallout. This was accomplished in large part by making refundable tax credits available to businesses and business owners.
Small business owners spent 2020 and 2021 and the years that follow trying to claim the tax breaks Congress was providing. Some of those breaks were generous. The refundable sick and family leave credits for self-employed people were among the most generous of all. They put real cash back in the pockets of barbers, drivers, and one-person shops that had to shut down.
But a refundable credit is a magnet for IRS scrutiny. The IRS pays these credits out even when the taxpayer owes no tax. That makes them easy to claim and easy to abuse. So the question is simple. What does it actually take to keep one of these credits when the IRS comes calling? And the IRS is now calling, long after the pandemic.
A recent case answers that question. In Hubbard v. Commissioner, T.C. Memo. 2026-62, the court considered what a self-employed taxpayer has to prove to hold onto the COVID leave credits. The answer is more than most people expect.
The Facts & Procedural History
The taxpayer worked odd jobs. He described himself as a barber, a musician, and a chef. He ran the multiservice operation out of the home he rented. He said he took payments through Zelle, Cash App, and cash.
For the 2021 tax year he filed a return with a Schedule C reporting a small amount of net business income. On top of that he claimed almost $32,000 in refundable COVID-19 sick and family leave credits. He also left off about $23,000 in unemployment compensation that the state had reported to the IRS on a Form 1099-G.
The credits dwarfed the reported business income. And the return skipped income that a third party had already told the IRS about.
The IRS audited the return and issued a notice of deficiency. It disallowed the business income, the expenses, and the tax credit. It also added back the unreported unemployment pay. The taxpayer petitioned the U.S. Tax Court to contest the determination.
What Are the Self-Employed Leave Credits?
This is not a new provision. It is a narrow one.
Congress created the refundable credits in 2020 through the Families First Coronavirus Response Act, then extended and expanded them in 2021 through the American Rescue Plan Act.
The idea was straightforward. Employees who missed work for COVID reasons got paid leave, and their employers got a payroll tax credit to fund it. Self-employed people had no employer. So Congress gave them an equivalent credit they could claim on their own returns.
The credit is refundable. That word matters. A refundable credit is not just an offset against tax you owe. If the credit is larger than your tax, the IRS sends you the difference as a payment. That is why these credits draw attention. The government is writing checks, and it wants to know the checks are going to the right people.
The Threshold Nobody Talks About
Here is the part that trips people up. Before you ever get to the leave rules, you have to clear a threshold. You have to actually be engaged in a trade or business.
The credits are tied to self-employment income from a trade or business. No business, no credit. It does not matter how sick you were or how many days you missed. If there is no qualifying business behind the return, the analysis ends before it starts.
The courts have long said that a trade or business requires continuity and regularity, and a real profit motive. A hobby does not count. An occasional side gig may not count. The court looks at the facts of each case, and the taxpayer carries the burden of showing the activity rises to the level of a business.
In this case the taxpayer could not clear that bar. His log of payments was vague. It showed money coming in from the same people through Zelle and Cash App, with no explanation of what the money was for. The numbers in the log did not even match the numbers on his Schedule C. The court found the records did not show a real business at all.
That was enough to sink the credits. The court held that on the threshold requirement alone, the taxpayer was ineligible.
Why Isn’t Testimony Enough?
Taxpayers often assume that showing up and telling their story will carry the day. It usually will not. The court is not required to accept self-serving testimony, especially when the documents do not back it up.
That is a hard lesson for cash-based operators. A barber or a chef may run a perfectly real business and still keep terrible records. The money comes in through apps and cash, and nobody writes down why. Unfortunately, IRS agents do not care that the work was real if the paper trail does not prove it. And for many small operators, reconstructing that trail years later is close to impossible, by the way.
So naturally, there is a second problem waiting even for the taxpayer who does prove a business. You still have to substantiate the leave itself.
What Documentation Does the Credit Require?
Even if the taxpayer had a business, he still lost. The court said the credits require specific documentation, and he did not have it.
To claim these credits, a self-employed person is supposed to file Form 7202 with the return. That form does the math and ties the credit to eligible leave days. The taxpayer here never filed it.
Filing the form is only the start. The IRS guidance asks the taxpayer to keep records showing the reason for the leave, the dates of the leave, and a statement that the person could not work for a COVID-related reason. The taxpayer testified that he was sick at some point during the year. But he could not give the dates. He had no records tying his time off to any of the qualifying reasons in the statute.
The court noted that a vague claim of illness is not the same as proof of a qualifying need for leave. There are cases where a taxpayer’s credible testimony can fill a gap, but this is the general rule: without the dates and the reason, the credit does not survive an audit.
The Unreported Income Problem
The credits were the centerpiece, but the missing income made everything worse. The state had issued a Form 1099-G reporting the unemployment pay. When a third party reports income to the IRS, that report gives the IRS enough of a foundation to treat the income as real.
The burden then shifts to the taxpayer to prove otherwise. The fact that it was unemployment income suggests that there was no business. The facts around this are not all that clear in the case. The taxpayer argued the payments were fraud committed in his name. That is a real thing, and it happens.
But the taxpayer filed his fraud claim with his bank, not with the state that issued the 1099-G. He never showed how the claim came out. The court could not find that the income was not his, so the adjustment stood. When you dispute a 1099, you have to dispute it with the payer and see it through.
The Takeaway
The lesson from this case is bigger than one barber’s return. Refundable credits are the IRS’s favorite audit target because the government is paying cash. If you claimed the self-employed COVID sick and family leave credits, assume the IRS may ask you to prove them. Proving them takes two things. First, records that show a genuine trade or business, not just a stream of app payments. Second, documentation of the leave itself, with the dates and the COVID-related reason you could not work. If you are staring at a notice questioning these credits, do not rely on memory. Build the paper trail before you respond, and get a tax attorney to help present it.
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