With the growing number of people turning their hobbies into businesses, it’s important to understand when the Internal Revenue Service (IRS) classifies a hobby as a business. As a business, you can make deductions for expenses and you have the chance of taking a loss if that business is not profitable. On the other hand, if the IRS classifies the activity as a hobby, you aren’t able to deduct those expenses or take a loss to offset income. If you’ve thought about turning your business into a hobby, it’s important to know how the IRS classifies the two.

A Business is For-Profit

Commonly, tax professionals refer to the hobby-business rule to determine if an activity is a hobby or a business. In the eyes of the IRS, an entity that is intended to profit is considered a business, while an activity that is not intended for profit is a hobby. If the purpose of your activity is to make a profit or earn income and is actively looking for profit or income regularly, then the IRS classifies that as a business. This is the hobby-business rule.

Who Does the Hobby-Business Rule apply to?

This rule should be understood by anyone that wants to turn their hobby into an income. However, this rule only applies for small businesses that are sole-proprietorships, LLCs, or partnerships. This rule does not apply to S Corporations and Corporations.

Factors That The IRS Considers in Their Determination

There are nine factors that the IRS uses to determine if the activity is a business or a hobby.

  1. Does the taxpayer keep business records, have a business checking about and generally conduct the activity as if it is a business?
  2. Does the taxpayer put time and effort into expanding and other marketing activities to increase customer counts?
  3. Does the taxpayer depend on income from the activity to live?
  4. Are the business losses typical start up losses or are the beyond the taxpayers control?
  5. Does the taxpayer make changes to the operation for increased profit?
  6. Is the taxpayer and expert in the activity and hire business advisors?
  7. Has the taxpayer previously had success in a similar business?
  8. Does the taxpayer profit in some years?  How much profit?
  9. Does the taxpayer expect to profit in coming years?

Income that comes from selling crafts, breeding dogs, photography and writing are more likely to be deemed as hobbies rather than businesses. If your business is a hobby, your deductions will need to be addressed. If you report false or incorrect information regarding your activity, the IRS might perform and audit to ensure that you are correctly filing your taxes.

At BFG Tax Help in Richardson, TX, we understand small business taxes. Our team can help you determine if the IRS may see your activity as a business or hobby and help you get prepared for either scenario.

m here to answer your questions and help you stay out of hot water with the IRS.

In your corner,

Teresa Bilsky
BFG Tax Help