Is Your Business Considered a Hobby by the IRS?

Are you running a business? Or just having fun with a hobby?

The IRS has strict rules for determining the difference between a business and a hobby for tax purposes. While expenses incurred to conduct a business are deductible, expenses incurred for a hobby may not be, causing your taxes to increase.

A person that conducts an activity for profit is allowed to deduct the expenses that are ordinary and necessary in that industry. If the expenses exceed the income, a loss is incurred. This loss can offset other income such as wages, interest or dividends.

However, if your activity is determined to be a hobby for IRS purposes, you cannot reduce your wages, interest or dividends by any losses.

When you have losses for three years in a row, you must be able to prove to the IRS that your activity is truly a business and not a hobby.

The IRS will consider the following when evaluating your business/hobby:

  • The manner that you carry on the activity
  • The expertise of the taxpayer in this industry as well as the taxpayer’s history and success in this industry
  • The time and effort spent in the activity and whether the taxpayer depends on the income for their livelihood
  • The elements of personal pleasure or recreation

Even if you have losses, there is a lot you can do to ensure your business is not considered a hobby. Here are some ideas to implement.

  1. Develop a written business plan and update it annually. Show how you plan to convert your losses into gains.
  2. Set up a separate business bank account and credit card account(s), and use them only for business purposes.
  3. Keep thorough and professional books.
  4. Obtain insurance, registrations, certifications, and licenses needed for that type of industry.
  5. Maintain a second phone listing for business.
  6. Keep a detailed calendar of your business activities. Record time spent on your business.
  7. Document evaluations of your operation to attempt to improve the business’s profitability.
  8. Research trends in similar businesses.
  9. Log any personal use on assets, such as a camera or automobile.

If there’s any question that your activities could be considered a hobby, these tips will help you stay proactive for tax purposes.

On March 6, 2023   /   Tax Tips