Hobby or Business? How to tell the difference for tax Purposes
March 20th, 2023
Whether it's something you've been doing for years or something you just started to make extra money, you must report income earned from hobbies on your tax return.
What's the difference between a hobby and a business? A business operates to make a profit. A person engages in a hobby for sport or recreation, not to make a profit.
Nine things to consider when determining if an activity is a hobby or a business:
1. Is the activity carried out in a businesslike manner, maintaining complete and accurate books and records?
2. Is the time and effort you put into the activity show an intent to make it profitable?
3. Do you depend on income from the activity for your livelihood?
4. Were any losses due to circumstances beyond your control or normal for the startup phase of your type of business?
5. Have you changed methods of operation to improve profitability?
6. Do you and your advisors have the knowledge needed to carry out the activity as a successful business?
7. Have you been successful in making a profit in similar activities in the past?
8. Has the activity yielded a profit and if so, how much profit?
9. Can you expect to make a future profit from the appreciation of the assets used in the activity?
Practical Standard of Business Classification:
If you have a profit in at least three of five consecutive years, the IRS will presume that you are engaged in the activity for profit under safe harbor rules. If you have concerns that your for-profit business is generating a loss and could be considered a “hobby” by the IRS, the following factors improve your position that you are operating a business and not a hobby:
Setting up a separate business checking account
Keeping business and personal expenses separate
Maintaining a good business record-keeping system
Registering your business with the state as an LLC
Having regular business hours or maintaining a business website
If you need assistance determining if your activity is a business or hobby, assistance with tax planning for your business, or any other questions please contact our office to set up a meeting.