Business or hobby? The IRS has their own opinion!
The IRS has defined a hobby as an activity you engage in “for sport or recreation, not to make a profit.” Should you turn your hobby into a business and bare your books to the IRS? Not necessarily, or perhaps not yet. The IRS allows some leeway when it comes to hobbies–unless you’re in the business of raising, training, racing or generally dealing with horses, in which case, here you go…
You can sell a lot of doggie bandanas before the IRS wants a piece of the action.
You can generally deduct expenses for those cute little doggie accessories. Things like fabric, labels and scissors. You might need a sewing machine if you get real creative and all sorts of other bandana producing stuff “for recreation, not to make a profit.” These are expenses considered ordinary and necessary for the particular hobby (do kibbles for the models count?) The IRS even allows you a bit of “hobby income.”
But, as a hobby, any expenses in excess of income are considered personal losses and not deductible from other income. So watch out, don’t purchase fabric to make a hundred big dog bandanas when your customers showed up with little lap dogs. That could become a non-deductible personal loss!
So, when is this a taxable business or hobby? Will the IRS let you know?
It’s best you recognize your hobby as a business before the IRS shows up to inform you. Are you making money, are you finding yourself worrying about taxable income? Are you spending what should be Quality Family Time in front of your computer with QuickBooks? These are clues that you’re well on your way to becoming a successful small business owner, and you need to start acting like one. Call it what it is. A business. Enjoy your business passion. Feel your inner puppy. Make bandanas and toss the dog a kibble. Get some help with your accounting and tax preparation.
What does the IRS have to say about your business or hobby?
The IRS would consider your passion as a business or hobby based on whether it makes a profit during at least three of the last five tax years, including the current year. They also like for you to be able to prove it. Let’s ask the IRS how they distinguish between whether what you do is a business or hobby, and their answer is here. Also a portion of their answer below:
In making the distinction between a hobby or business activity, take into account all facts and circumstances with respect to the activity. No one factor alone is decisive. You must generally consider these factors to establish that an activity is a business engaged in making a profit:
- Whether you carry on the activity in a businesslike manner.
- Whether the time and effort you put into the activity indicate you intend to make it profitable.
- Whether you depend on income from the activity for your livelihood.
- Whether your losses are due to circumstances beyond your control (or are normal in the startup phase of your type of business).
- Whether you change your methods of operation in an attempt to improve profitability.
- Whether you or your advisors have the knowledge needed to carry on the activity as a successful business.
- Whether you were successful in making a profit in similar activities in the past.
- Whether the activity makes a profit in some years and how much profit it makes.
- Whether you can expect to make a future profit from the appreciation of the assets used in the activity.
What to do?
Enjoy your business passion and enjoy your business success. If you’re doing what you love (feeding kibbles to your models while making bandanas) keep it up, and…