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What is the difference between a hobby and a business?

Article ID: 69
Last updated: 15 Dec, 2013
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By Jason Watson ()

The hobby versus legitimate business is a common question. We have written a series of KB articles on this topic as well.

Here is a quick summary- First, the IRS suggests that incorrect deduction of hobby expenses account for a portion of the overstated adjustments, deductions, exemptions and credits that add up to $30 billion per year in unpaid taxes. So there is a bit of an incentive for the IRS to tackle this issue head on.

Generally, an activity qualifies as a business if it is carried on with the reasonable expectation of earning a profit. In order to make this determination, taxpayers should consider the following factors:

  • Does the time and effort put into the activity indicate an intention to make a profit?

  • Does the taxpayer depend on income from the activity?

  • If there are losses, are they due to circumstances beyond the taxpayer’s control or did they occur in the start-up phase of the business?

  • Has the taxpayer changed methods of operation to improve profitability?

  • Does the taxpayer or his/her advisors have the knowledge needed to carry on the activity as a successful business?

  • Has the taxpayer made a profit in similar activities in the past?

  • Does the activity make a profit in some years?

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

Again, the main theme is reasonable expectation of earning a profit.  The IRS presumes that an activity is carried on for profit if it makes a profit during at least three of the last five tax years, including the current year. Having said that, there is a recent Tax Court case docketed October 25 2012 showing how a taxpayer with eight consecutive years of losses was able to demonstrate that his business was trying to earn a profit.

Read the full opinion at www.watsoncpagroup.com/Coach.pdf.

We also encourage you to read our article on the Hobby versus Business topic- it expands on this question and answer more in depth.

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item Hobby Versus Business Article
item What business or corporate expenses can I deduct?
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