Hobby vs Business
Hobby vs. Business
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Hobby or Business?
If an individual, partnership, estate, trust, or an S corporationengages in an activity that is not conducted
as a for-profit business, expenses (other than cost ofgoods sold) are not deductible. This rule does not apply
to corporations, other than S corporations. If an activityis considered a for-profit business, deductions can exceedincome, allowing the resulting loss to offset other income.
Determination
In determining whether an activity is a hobby or a business,all facts and circumstances are taken into account.
No one factor can make the determination. The followinglist is not intended to be all inclusive.
1) The manner in which the taxpayer carries on theactivity. Factors that may indicate a business include
maintaining complete and accurate books and records,carrying on the activity substantially similar
to other profitable activities of the same nature, andchanging operating methods and techniques to improve
profitability.
2) The expertise of the taxpayer or his or her advisors.Factors that may indicate a business include
knowledge of the taxpayer, or consultation with thosewho are knowledgeable about a particular industry,
then using that knowledge to try and make a profit.
3) The time and effort expended by the taxpayer incarrying on the activity. Factors that may indicate a
business include spending a lot of time and effort inthe activity, particularly if the activity does not have
substantial personal or recreational aspects.Taking time away from another occupation may also
indicate a profit motive. Spending little time will notbe counted against the taxpayer if qualified employees
are hired to carry on the activity.
4) The expectation that assets used in the activity mayappreciate in value. Even if no profit is made from
operations, if the value of land or other assets in theactivity appreciate so that an overall profit is made
from a sale, the activity may be considered a business.
5) The success of the taxpayer in carrying on othersimilar or dissimilar activities. If the taxpayer was
successful in the past turning an unprofitable ventureinto a profitable venture, the current activity may be a
business even if it has not yet made a profit.
6) The taxpayer’s history of income or losses withrespect to the activity. Early losses during start-up
will not count against the taxpayer, but continuedlosses after the customary start-up stage that are not
explainable may indicate a hobby. Losses sustaineddue to unforeseen circumstances, such as casualty or
thefts beyond the taxpayer’s control, will not countagainst the taxpayer. Any series of profitable years
are strong evidence the activity is a business.
7) The amount of occasional profits, if any, whichare earned. The amount of profits in relation to the
amount of losses, and in relation to the taxpayer’s investmentin the activity, may indicate intent. An occasional
small profit one year, mixed with large lossesin other years or large taxpayer investments, may indicate
the activity is a hobby. Substantial occasionalprofits mixed with frequent small losses or investment
may indicate a business. An opportunity to earnsubstantial ultimate profits in a highly speculative
venture also indicates a profit motive.
Hobby vs. Business
an8) The financial status of the taxpayer. If the taxpayerdoes not have substantial income or capital from
other sources, the taxpayer may have a profit motive.If the taxpayer has substantial income from other
sources, and losses from the activity in question generatesubstantial tax benefits, the taxpayer may not
have a profit motive.
9) Elements of personal pleasure or recreation. Wherethere are recreational or personal elements involved
with the activity, a lack of profits may indicate a hobby.On the other hand, a lack of any appeal in the activity
other than possible profits indicates a profit motive. It is not necessary that the sole purpose for engaging inan activity is to make a profit. The availability of other investments that might produce a higher rate of return
will not count against the taxpayer. The fact thata taxpayer derives personal pleasure in the activity is
not sufficient in itself to classify the activity as a hobbyif other factors indicate the activity is a business.
Presumption of Profit
IRS rules state that if an activity is profitable in threeof the last five tax years, including the current year, the
presumption is it is carried on for profit, and the hobbyloss limitations do not apply. If the activity consists primarilyof breeding, training, showing, or racing horses,
the IRS will presume it is carried on for profit if a profitis produced in at least two of the last seven tax years, including the current year.
Reporting Hobby Income and Expenses
Occasional profits from hobby activities are not subjectto self-employment tax and are reported as Other Incomeon line 21, Form 1040.
Hobby Income
Gross income for the purposes of the hobby loss rulesequals gross receipts minus the cost of goods sold deduction.Hobby income may include capital gain, rent and other income.
Hobby Expenses
Under the Tax Cuts and Jobs Act, for tax years 2018 – 2025,expenses related to hobby income are not deductible asmiscellaneous itemized deductions subject to the 2%AGI limit on Schedule A (Form 1040).
Activities Not Engaged in for Profit
IRS examiners consider the following in their analysisto determine whether or not an activity is engaged in
for profit.
• Are there activities with large expenses and little orno income?
• Are losses offsetting other income on the tax return?
• Does the activity result in a large tax benefit to the taxpayer?
• Does the history of the activity show that it is generating
any profit in any years?
Examples of possible hobby activities include:
– Airplane Charter – Games
– Artists – Gardening
– Auto Racing – Horse Breeding
– Boating – Horse Racing
– Bowling – Jewelry Making
– Collecting – Knitting
– Cooking – Motocross Racing
– Craft Sales – Music
– Direct Sales – Outdoor Recreation
– Dog Breeding – Photography
– Entertainers – Rentals
– Farming – Stamp Collecting
– Fishing – Woodworking
– Fishkeeping – Writing
– Gambling – Yacht Charter
Contact Us
There are many events that occur during the year that can affectyour tax situation. Preparation of your tax return involves summarizing transactions and events that occurred during the prior year. In most situations, treatment is firmly established at the time the transaction occurs. However, negative tax effects can
be avoided by proper planning. Please contact us in advanceif you have questions about the tax effects of a transaction or
event, including the following:
• Pension or IRA distributions.
• Significant change in income or
deductions.
• Job change.
• Marriage.
• Attainment of age 59½ or 70½.
• Sale or purchase of a business.
• Sale or purchase of a residence
or other real estate.
• Retirement.
• Notice from IRS or other
revenue department.
• Divorce or separation.
• Self-employment.
• Charitable contributions
of property in excess of
$5,000.
