Small Business Reading Room

Tuesday, August 26, 2008

Do you have a hobby or do you have a business?

It may not matter much to you in the end, but it could make a difference come tax time.

In general, taxpayers may deduct ordinary and necessary expenses for conducting a trade or business or for the production of income. Trade or business activities and activities engaged in for the production of income are activities engaged in for profit. The “hobby loss rule”, aka Internal Revenue Code Section 183 (Activities Not Engaged in for Profit) limits the deductions that can be claimed when an activity is not engaged in for profit. In short, if an activity is not for profit, losses from that activity may not be used to offset other income.

The following factors come from an IRS educational fact sheet, and although they are not all inclusive, they may help you to determine whether your activity is an activity engaged in for profit or a hobby:

Does the time and effort put into the activity indicate an intention to make a profit?

Do you depend on income from the activity?

If there are losses, are they due to circumstances beyond your control or did they occur in the start-up phase of the business?

Have you changed methods of operation to improve profitability?

Do you have the knowledge needed to carry on the activity as a successful business?

Have you made a profit in similar activities in the past?

Does the activity make a profit in some years?

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

If you have questions and need a clearer understanding of what constitutes an activity engaged in for profit and the tax implications of incorrectly treating hobby activities as activities engaged in for profit, you should speak with your accountant or tax preparer for advice.

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Small Business Reading Room

Do you have a hobby or do you have a business?

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