Many activities can be scrutinized by the IRS to determine if they are truly a business activity or a hobby. This is important because hobby losses are limited to the amount of income that is generated and are also subject to a floor of 2% of adjusted gross income as a miscellaneous itemized deduction. If your eyes just glazed over, you should look at these nine factors and consult with your CPA to determine if you have a for-profit business or a hobby.
- How do you carry on the activity? Is it handled in a businesslike manner? Do you have separate personal and business bank accounts? Do you keep books and records?
- What is your expertise? Do you have extensive knowledge of the profession or activity? Have you studied business methods or have you sought advice from experts?
- Do you expend substantial time and effort in carrying out the activity? Is this time spent with the honest objective of making a profit?
- Is there any expectation that assets used in the activity may appreciate in value? Do you have assets that have a value that exceeds losses?
- Even if you have losses, have you been able to convert similar activities to profitable in the past?
- What is your history of income or losses from the activity? The economy may fluctuate and cause you to incur losses but what is the trend with losses? Are they sustained over a long period of time?
- What is the relation of losses to income earned, investment in the activity and the value of assets used in the activity?
- What is your financial status? Do you have income from other sources? Is this your main source of income?
- Does the activity provide recreation or does it involve personal motives? This goes beyond liking your job and looks more that the possibility that the activity is more for enjoyment than for profit. For example a ski instructor might get more recreation out of their business than a janitor.
No one of these factors can determine if you are running a business or a hobby. They must all be considered together and taken as a whole. If you have questions about whether your activity is a business or if it could be deemed a hobby by the IRS, see your tax preparer at JamisonMoneyFarmer to discuss your situation!