Millions of taxpayers have hobbies. Some of these hobbies generate income for taxpayers, while others actually are legitimate business enterprises. Whether it is a true business or a hobby, taxpayers must report any income earned from hobbies. IRS rules and regulations for reporting income and expenses depend on whether an activity is a hobby or a business. Thus, taxpayers must observe special rules and limits for the deductions that may be claimed for income earned from hobbies. So, when is a hobby a business?
The IRS considers a legitimate business yo be an activity that has a primary purpose of “income or profit” and is engaged in “with continuity and regularity.” A hobby is not a business if it hasn’t shown a net profit in, at least, three of the last five tax years. The IRS typically considers many factors in determining whether an activity is a business engaged in making a profit. No one factor alone is decisive in conclusively establishing that an activity is a hobby or business.
Nonetheless, there is one key distinction between a business and a hobby. While people operate a business for profit, they generally participate in a hobby solely for sporting or recreational purposes. For any taxpayer who needs to make the important distinction between hobby or business, all facts and circumstances related to the activity must be considered.
The aforementioned factors include the following:
- Whether the activity is carried on in a businesslike manner, and the taxpayer maintains complete and accurate books and records;
- Whether the time and effort put into the activity indicates an intention to make it profitable;
- Whether the taxpayer depends on income from the activity for his or her livelihood;
- Whether any losses from the activity are due to circumstances beyond the taxpayer’s control or are normal in the startup phase of that type of business;
- Whether the methods of operation are changed to improve profitability;
- Whether anyone involved in the activity has the knowledge needed to carry on the activity as a successful business;
- Whether the taxpayer was successful in making a profit from similar past activities;
- Whether the activity makes a profit in some years and the extent of any profit; and
- Whether there is an expectation that some profit in the future will occur from the appreciation of assets used in the activity.
The consideration of the factors listed above may involve a complex analysis. An Atlanta tax attorney experienced in handling business-related tax cases can assist any taxpayer with this determination. The Gartzman Law Firm handles all types of tax cases. Use our contact form to request a consultation with an Atlanta tax resolution attorney or call The Gartzman Law Firm at (770) 939-7710.