Business or Hobby Income?

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We are committed to helping each of our clients succeed. For this reason our employees attend specialized classes and conferences to keep up-to-date with the latest audit, accounting, and tax requirements.

It’s important to distinguish between what is considered a hobby activity and what is considered a business activity for your tax return. For a business, you can deduct any expenses that occurred as long as the expenses are both ordinary and necessary to the activity. Hobbies expenses differ in that they are limited to the amount of income you made from the hobby activity. So, if you are taking a loss on a business that is actually a hobby it can result in consequences for you.  According to the IRS you should ask yourself these nine questions to determine if you have hobby income or business income:

  • Are you carrying on the activity in a businesslike manner?

  • Is the time and effort you put into the activity indicate you intend to make it profitable?

  • Do you depend on income from the activity for your livelihood?

  • Are your losses due to circumstances beyond your control?

  • Have you change your methods of operation in an attempt to improve profitability?

  • Do you or your advisors have the knowledge needed to carry on the activity as a successful business?

  • Were you successful in making a profit in similar activities in the past?

  • Did the activity makes a profit in some years and how much profit it makes?

  • Do you expect to make a future profit from the appreciation of the assets used in the activity?

The IRS also gives guidance on if an activity is carried on for profit. An activity is considered for profit and not a hobby if it has produced a profit for 3 of the last 5 tax years. For activities involving breeding, training, showing, or racing horses to be considered for profit they must have produced a profit for 2 of the last 7 tax years. If your business does not meet the requirements to be considered for profit, the burden of proof is then on you to prove that you actually run a business. This can be done by meeting some of the nine determining factors listed above. 

Claiming an activity that is a hobby as a business can result in a tax audit. If the IRS rules that you are claiming a hobby as a business, you may have to pay additional taxes, interest, and possible penalties for underpayment of previous tax years’ liabilities. So when you are filing your tax return next year, please take into consideration if you have a business or if it is really just a hobby. Contact us at 1-866-287-9604 with any questions.

Posted by Casey Hasty