Hobby vs Business

In today’s technology driven age many Americans are taking advantage of being able to share with the world their hobbies. Websites like eBay, and even Facebook allow users to sell their own handmade goods and help turn their past times into profits. While many people don’t rely on this as their main source of income there are certain things to know when it comes to the tax implications of what the IRS considers a hobby or a business. The IRS defines a hobby as an activity that is not pursued for profit, where as a Business is an activity that is carried out with the reasonable expectation of earning a profit.  For each activity the tax considerations differ, so it is important to know which activity you are engaging in. Almost all sources of income must be reported and taxes paid, but when it comes to deductions each have their own tax implications.

The following criteria will help you understand which category you fall under:

          Do you depend on the income from the activity?

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

          If there are losses, were they beyond your control or did they occur in the start-up phase?

          Have you changed methods of operation in order to improve profits?

          Do you, or your advisors, have the knowledge to continue the activity as a successful business?

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

          Have you made a profit with this activity in some years?

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

The IRS will look at several factors to decide if your hobby is for pleasure or business purposes. The primary factor is the profit test. If you have made a profit during at least three of the last five tax years, including the current year, then the IRS presumes that you have engaged in this activity for profit. Once deemed business activity you can deduct ordinary and necessary expenses for operation.

 If the activity is not for profit, any losses may not be used to offset other income and you may only deduct expenses up to the amount of income earned from the hobby. 

The above information is of a general nature only and should not be relied upon for specific situations. Click here for additional tax services information.

Call Marlies Y Hendricks CPA PLLC at either 716-694-3500 or 910-769-8730 as required to set up an appointment.