If you’re in business for yourself, chances are that you enjoy it or you’d be doing something else. If your business isn’t making money, or if it’s something you do for fun on the side, the IRS may start asking if your business is actually a hobby. The American Institute of CPAs recently sent out a reminder that if an activity is to be considered a business, it must be engaged in for profit. If the activity is not engaged in for profit, it is subject to the hobby loss rules in Sec. 183.
So how do you know if your business is truly a business and not a hobby? Here are nine factors listed in Regs. Sec. 1.183-2(b) to help you decide.
- How do you handle the business? You can demonstrate that you’re treating the activity like a business by having a separate business bank account, keeping accurate records and books, and otherwise functioning as a business would.
- What is your expertise? If you have education and experience in your field of endeavor, the IRS will consider that you’re a business professional.
- How do you spend your time? Dedicating a significant amount of time in your activity shows that you treat is seriously and intend to make a profit.
- If you have assets used in your business, are they appreciating? Regs. Sec. 1.183-2(b)(4) states that asset appreciation (such as land) may be considered in lieu of current profits.
- Is there a likely chance that you’ll become profitable in the near future? If you have demonstrated that you can take unprofitable activities and make them profitable, the IRS is likely to give you a chance to make it in your current venture.
- What’s your income and loss history from the activity? If you’ve been profitable in the past but you’re now struggling since the economy tanked, the IRS will realize that your intent is for profit and you’ll probably get back on track.
- What are the amounts of your profits and losses? The IRS looks at the ratio of profits and losses to your investment in the business and the value of the assets you’re using in it.
- What’s your financial status? Is the majority of your income coming from elsewhere? If so, the IRS may view your activity as a hobby. If you’ve got all your bets placed on your business, however, you show that you’re serious about making it work. The exception is if your business is seasonal — if you have a job in the off-season of your business and you’re relying on your business income during the season you’re actively in business, the IRS views it as legitimate.
- Do you have personal motives that exceed your profits? This one is tricky, since everyone’s goal is to enjoy their work. But if your business provides you with too much recreation and not enough profits, the IRS will be raising an eyebrow.
If you still have questions about whether your business would cause the IRS to classify you as a hobbyist, feel free to get in touch and we’ll talk about your situation.