Do You Have a Hobby or a Business?

It is important to determine whether you have a hobby that makes some income as part of an activity you engage in for pleasure or recreation or a business that operates to make a profit because the IRS will treat these cases differently. In either case, you must report any taxable income to the IRS on your federal tax return, and if you receive payments through an online service or payment app, you will probably receive an IRS Form 1099-K for those transactions.

Will the IRS consider your activity a hobby?

Questions to Determine the Nature of Your Activity: Business or Hobby

Answers to the following IRS questions can help you decide which one you have.

Does the activity make a profit some years?

Do you depend on income from the activity for your livelihood?

Are you taking steps to improve your profitability?

Do you engage in the activity in a businesslike manner, keeping complete and accurate records?

Do any losses reflect startup costs associated with establishing a business or are they the result of circumstances outside of your control?

Does the amount of time and effort you put in the the activity reflect your drive to make a profit?

Do the taxpayer and associates in the activity have knowledge and skills required to turn the activity into a business?

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

Will the IRS consider your activity a business?

Businesses Have Revenue

While hobbies can turn into businesses over time, you can’t deduct expenses related to recreational activities, even if they are expensive. If the IRS determines that you have a hobby and not a business, they will not accept your write-offs and expenses. Generally, if you aren’t declaring revenue within about three years, your enterprise will most likely be considered a hobby. Businesses are run to make a profit, not merely to serve as write-offs for other income.

Be Sure to Treat a Business like a Business

Answering yes to any of the questions above could suggest that you have a business, not just a hobby. If you are engaged in an activity that is making a profit and has expenses, be sure to treat it like a business. Report all of your income, consider paying estimated taxes so that you don’t receive any penalties or interest on unpaid quarterly taxes, and keep excellent records and receipts for all of your expenses. As the business grows, consult a CPA or other advisory on how best to structure (e.g., S-Corp or LLC) and file your business. At some point, filing Schedule C on your personal returns may be a costly mistake, especially if all you have are expenses.

Accelerated Tax Solutions Can Help with Your Audit or Reconsideration (CP504)

Many of our clients at Accelerated Tax Solutions reach out to us when they have issues with their Schedule C business years down the road when the IRS disallows their claimed expenses. Usually, these individuals have claimed expenses related to their business-like activity without ever claiming revenue. If they did have revenue, the expenses eclipsed any funds that they received. Although these imbalances can occur during a business startup period or a time of hardship, be sure to keep documentation of all of your expenses. Bank statements won’t be enough. The IRS will want to see the receipts as evidence of these transactions. Armed with an expertise and documentation, our legal team regularly engages the IRS to make a case for the highest amount of expenses and deductions allowable by law in order to reduce the assessed tax liability. We also advise these clients how to move forward so that they will not land back in the audit department or have their business declared a hobby.