If you are engaged in an activity that you do for the enjoyment of the activity but also make money, it is important to understand whether it is a business or hobby for tax purposes. The Internal Revenue Service (IRS) has different tax treatment for businesses and hobbies. It’s important to understand the difference for the following reasons:
- Business expenses are deductible from business income, while hobby expenses are only deductible up to the amount of hobby income.
- Business losses can be used to offset other income, while hobby losses can only be used to offset hobby income.
- Business assets can be depreciated for tax purposes, while hobby assets cannot be depreciated.
If you are audited, the IRS may look at an activity that you consider a business and recategorize it as a hobby. If you wish to receive treatment as a trade or business, you should keep the following factors in mind:
- Profit motive: The primary motivation for the activity must be to make a profit. If the primary motive is not to make a profit, the activity may be considered a hobby.
- Regularity: The activity should be conducted regularly and continuously. If the activity is occasional or sporadic, it may be considered a hobby.
- Businesslike Activities: The activity should be performed in a business-like manner and maintain accurate books and records. If the activity is performed in a casual or haphazard manner, it may be considered a hobby.
- Time and effort: The activity should involve significant time and effort. If the activity is a minor or incidental part of the taxpayer’s life, it may be considered a hobby.
- Historical success: Does the activity have a history of generating profits? If the activity has not generated a profit in prior years, it may be considered a hobby.
- Reasonable expectations of profitability: The taxpayer must have a reasonable expectation of profitability in the future based on prior performance, market conditions, and other relevant factors. If the taxpayer does not have a reasonable expectation of profitability, the activity is considered a hobby.
These factors are not exclusive and the IRS will consider all relevant facts and circumstances in determining whether an activity is a business or a hobby.