Is Your Business a REAL Business or a Hobby?
Tuesday July 8, 2008
Earlier this week I wrote a post on my Small Business Boomers blog about the "hobby loss" issue in small business taxes. It works like this:
Someone starts a hobby, like quilting, woodworking, traveling, and decides to make a business out of it. They start collecting expenses and they put these expenses on their income tax return as a "business." They might make a little money here and there, but they are really not trying very hard. When they try to claim the expenses as a "business deduction," the IRS says no. If you would like your hobby to be considered a real business, there are some things the IRS considers that you should know about, set out in an IRS publication. Some factors the IRS considers:
Someone starts a hobby, like quilting, woodworking, traveling, and decides to make a business out of it. They start collecting expenses and they put these expenses on their income tax return as a "business." They might make a little money here and there, but they are really not trying very hard. When they try to claim the expenses as a "business deduction," the IRS says no. If you would like your hobby to be considered a real business, there are some things the IRS considers that you should know about, set out in an IRS publication. Some factors the IRS considers:
- Does the time and effort put into the activity indicate an intention to make a profit?
- Does the taxpayer depend on income from the activity?
- If there are losses, are they due to circumstances beyond the taxpayer’s control or did they occur in the start-up phase of the business?
- Has the taxpayer changed methods of operation to improve profitability?
- Does the taxpayer or his/her advisors have the knowledge needed to carry on the activity as a successful business?
- Has the taxpayer made a profit in similar activities in the past?
- Does the activity make a profit in some years?
- Can the taxpayer expect to make a profit in the future from the appreciation of assets used in the activity?
The IRS also looks at how many years the business has been in operation and whether it has made a profit - their "rule of thumb" is you should be profitable for 3 out of the last 5 years of operations.
If the IRS has sent you a letter expressing doubt about your business, you will need to send Form 5213, Election to Postpone Determination as to Whether the Presumption Applies That an Activity Is Engaged in For Profit. In other words, you'll have to prove that your activity is a real business and not just a hobby.
If all of this sounds like too much trouble, maybe you should just enjoy your hobby and not try to get your hobby expenses deducted.
Comments
What a racket. I guarantee you that if you make a few hundred dollars from it, you can’t avoid reporting it and claim, “It’s only a hobby.”
Best solution — earn at least a couple of dollars more than you spend. Then you don’t have to worry about it.
I agree. Just make a little profit – not too much. In other words, don’t spend too much. Easy to say, harder to do.