Is your business a business or a hobby?

Is It a Hobby or a Business?

Is your business really a business, or is it still just a hobby? The answer to that question will have an impact on your taxes at the end of the year.

Do You Intend to Make a Profit?

The IRS usually considers whatever you’re doing a business if you intend and expect to turn a profit. You can figure out if the IRS will treat you as a business by asking yourself some questions:

  •  Does the time and effort I put into the activity indicate an intention to make a profit?
  • Do I depend on income from the activity?
  • If there are losses, are they due to circumstances beyond my control, or did they occur in the startup phase of my business?
  • Have I changed methods of operation to improve profitability?
  • Do my advisors or I have the knowledge needed to carry on the activity as a successful business?
  • Have I made a profit by doing a similar activity in the past?
  • Has the activity made a profit in some years?
  • Can I expect to make a profit in the future from the appreciation of assets used in the activity?

If you answered, “yes” to most of those questions, then congratulations! The IRS will most likely treat your activity as a business.

According to the IRS, your activity is definitely a business if it has made a profit during at least 3 of the last 5 years (including the current year).

If your sales are a little slow right now and you’re still trying to grow your business, don’t worry. You could still be treated as a business, just be careful to do a few things:

Does It Really Matter?

At this point, you might be asking yourself, “Does it really matter if the IRS treats me like a hobby or a business?” Yes, yes it does.

As a business, you can deduct all ordinary and necessary expenses incurred from conducting your business. An ordinary expense is common and accepted in your trade or business. A necessary expense is appropriate for the business.

As a hobby, you can generally only deduct expenses up to the amount of income your hobby brought in. So, for example, if you bought $1,500 worth of equipment for your hobby, then only sold two things at $50 apiece, you could only deduct $100.

That also means that, if your activity is treated as a hobby, you can’t deduct a loss from the hobby from other income.

So, if you want the IRS to treat you as a business, make sure you’re trying to turn a profit.