Is it a Business or a Hobby?
An issue we deal with all the time with our clients is to help them distinguish if an activity is a Business or a Hobby. The difference is, legitimate business losses are potentially fully deductible. If the activity is deemed to be a hobby by the IRS, then you can only deduct legitimate hobby expense up to the amount of your hobby income, and then only if you itemize your deductions.
Sometimes it is hard to make a determination. Activities related to horse racing, horse shows, auto racing or auto restoration draw particular scrutiny by the IRS.
The following is a nine part test the IRS considers in deciding whether a taxpayer is running a business genuinely designed to make money or merely a hobby:
1. You carry on the activity in a businesslike manner.
2. The time and effort you put into the activity indicate you intend to make it profitable.
3. You depend on the income for your livelihood.
4. Your losses are due to circumstances beyond your control (or are normal in the startup phase for your type of business).
5. You change your methods of operation in an attempt to improve profitability.
6. You (or your advisers) have the knowledge needed to carry on the activity as a successful business.
7. You were successful in making a profit in similar activities in the past.
8. The activity makes a profit in some years (The guideline is profitable 3 out of the last 5 years).
9. You can expect to make a future profit from the appreciation of the assets used in the activity.
As usual, when considering this and other tax situations it comes down to making sure it passes the “Smell Test”.
You can contact us in Dayton at 937-436-3133 and in Xenia at 937-372-3504. Or visit our website.