Nine factors to consider
When it comes to taxes, you need to know whether the activity you conduct is a business or a hobby. This distinction is important because hobby expenses are limited to hobby income. A hobby cannot generate a tax loss.
To be considered a business, the activity must produce a profit for three out of five years. If the activity is horse breeding, racing, training or showing, it must make a profit for two out of seven years.
There are other factors to review when determining whether an activity is a hobby or a business. A taxpayer should answer the following questions that the IRS uses during an audit.
#1 Does the time and effort put into the activity indicate an intention to make a profit?
Spending extensive time and effort in carrying on the activity can indicate that there is a profit motive.
#2 Do you depend on the income from the activity?
If you depend on this activity as your only source of income, this makes a strong case of a profit motive.
#3 If there are losses, are they due to circumstances beyond your control or did they occur in the start-up phase of the business?
If losses continue after what is considered customary for the activity, it may indicate that the activity is not run for a profit.
#4 Have you changed methods of operation to improve profitability?
One of the most important things you can do is make sure you conduct your activity in a business-like manner. You should have a separate checking account that is only used to pay business expenses. Never pay personal expenses from the business account. Also, consider creating a written business plan. Keep all records, papers and receipts in an organized manner.
#5 Do you have the knowledge needed to carry on the activity as a successful business?
If you have extensive knowledge of the activity or consulted with experts, this may indicate that you have a profit motive.
#6 Have you made a profit in similar activities in the past?
If you have ever converted a similar activity from a loss to a profit, this may indicate that you are engaged in the current activity for a profit.
#7 Does the activity make a profit in some years?
Substantial profit, even when only occasional, would generally be indicative that an activity is engaged in for profit.
#8 Do you expect to make a profit in the future from the appreciation of assets used in the activity?
The assets that you use in the activity may appreciate in value.
#9 What elements of personal pleasure or recreation are involved in the activity?
The presence of personal pleasure does not necessarily mean the activity is simply a hobby, but it can be used as an indicator when the IRS is making a decision.
Of course, nothing is clear-cut when it comes to the IRS and taxes. If you are unsure whether your activity is a hobby or a business, schedule an appointment with one of our tax professionals to discuss your circumstances.
When it comes to taxes, you need to know whether the activity you conduct is a business or a hobby. This distinction is important because hobby expenses are limited to hobby income. A hobby cannot generate a tax loss.
To be considered a business, the activity must produce a profit for three out of five years. If the activity is horse breeding, racing, training or showing, it must make a profit for two out of seven years.
There are other factors to review when determining whether an activity is a hobby or a business. A taxpayer should answer the following questions that the IRS uses during an audit.
#1 Does the time and effort put into the activity indicate an intention to make a profit?
Spending extensive time and effort in carrying on the activity can indicate that there is a profit motive.
#2 Do you depend on the income from the activity?
If you depend on this activity as your only source of income, this makes a strong case of a profit motive.
#3 If there are losses, are they due to circumstances beyond your control or did they occur in the start-up phase of the business?
If losses continue after what is considered customary for the activity, it may indicate that the activity is not run for a profit.
#4 Have you changed methods of operation to improve profitability?
One of the most important things you can do is make sure you conduct your activity in a business-like manner. You should have a separate checking account that is only used to pay business expenses. Never pay personal expenses from the business account. Also, consider creating a written business plan. Keep all records, papers and receipts in an organized manner.
#5 Do you have the knowledge needed to carry on the activity as a successful business?
If you have extensive knowledge of the activity or consulted with experts, this may indicate that you have a profit motive.
#6 Have you made a profit in similar activities in the past?
If you have ever converted a similar activity from a loss to a profit, this may indicate that you are engaged in the current activity for a profit.
#7 Does the activity make a profit in some years?
Substantial profit, even when only occasional, would generally be indicative that an activity is engaged in for profit.
#8 Do you expect to make a profit in the future from the appreciation of assets used in the activity?
The assets that you use in the activity may appreciate in value.
#9 What elements of personal pleasure or recreation are involved in the activity?
The presence of personal pleasure does not necessarily mean the activity is simply a hobby, but it can be used as an indicator when the IRS is making a decision.
Of course, nothing is clear-cut when it comes to the IRS and taxes. If you are unsure whether your activity is a hobby or a business, schedule an appointment with one of our tax professionals to discuss your circumstances.
RSS Feed