Will The IRS Consider Your Business A Hobby?
Blog - September 2013
Could the IRS declare your business to be a hobby this year? Let’s find out if your business is set up properly. If an activity is not engaged in trying to turn a profit, then there are limits on the amount of deductions that can be taken against any income earned from the activity.
If your activity is considered a hobby by the IRS, then the total income goes on the first page of your standard 1040form, while the expenses are deductible on a Schedule A.
Note: In order to file Schedule A you have to have enough other expenses, such as mortgage interest, real estatetaxes and state/local taxes paid to total more than the standard deduction. ***Your total hobby expenses arenot allowed to be greater than your hobby income. Hobby expenses are subject to a 2% floor amount? Whatthat means is that you may deduct only those hobby expenses which are in excess of 2% of your Adjusted Grossincome.
If your activity is considered a business by the IRS, then the expenses that are greater than the income would be directly deductible. In other words, you can have a loss on a business, not on a hobby.
In determining whether it is a business, the IRS considers nine factors.
1. Is the activity conducted like a business? Does it have a separate checking account for all receipts and payments? That would be an account that is kept COMPLETELY separate from your personal accounts.
2. Does the business owner have in-depth knowledge of, or experience in, the industry?
3. Does the taxpayer spend substantial time in the activity? Is a significant amount of personal time and effort spent inthis activity or is this something done occasionally or only on weekends?
4. Is there an expectation of appreciation in value of business assets?
5. Even if it is currently unprofitable, has the taxpayer converted previous unprofitable ventures into profitable ones?
6. The IRS also looks at the history of income and losses from the activity. As a general rule, the IRS expects to seeincome in three of the last five years. And let’s face it, if you are in the activity to make a profit, why would you continueif you are losing money every year?
7. Relative profits and losses of the activity are reviewed in relation to the taxpayer’s investment and the value of thebusiness assets.
8. Another factor is the taxpayer’s financial status – are there other sources of income? Is the taxpayer working fulltime at another job or devoting all their time to the activity? Obviously, these are the two extremes and there is muchmiddle ground and circumstances that would still allow the activity to be considered a business.
9. Does the activity provide recreation or involve a motive that would indicate that profit was not the reason forengaging in the activity?
Not all of these are required in order to be considered a business, but they are guides to help you stay “in business”.