Updated: Jun 1
Business vs Hobby – What do you Have?
Do you think your hobby is a business? The IRS may not agree. Why does it matter? It all comes down to the taxes. If you have a business, you may take advantage of a variety of deductions and credits, including writing off your business losses. If it’s a hobby, you may take advantage of some deductions, but not nearly as many.
How do you tell the difference between a business vs a hobby? Answer these questions.
Business vs Hobby – Questions to Ask Yourself
1. Do you keep updated books?
Do you accurately track your revenue and expenses? How often do you track the market to determine how to improve your business? Do you only take on jobs that will improve your bottom line?
2. Is your intention to make a profit?
Do you put the time and effort in to make it profitable? The IRS measures your intent by looking at the last 5 years. Did you make a profit for at least 3 of those years? Net profit is your net income – net expenses. If this number is positive, you have a profit, and if negative you have a loss.
3. Do you put in enough time to make it profitable?
Do you work it often or do you only take part in the activity when you have time?
4. Is it your primary income?
Do you rely on the income to make ends meet? Even if it’s not your only job, can you prove you need the income to survive?
5. If you experienced losses, were they beyond your control?
For example, starting up a business may cause a loss because of the initial capital and low initial sales. If you experienced losses, can you prove that you did everything possible to avoid them?
6. Have you taken steps to improve your profits?
If you experienced a loss, did you take steps to improve it? Whether you added new products, removed a product, added a service, or changed your customer base, can you prove the changes you made?
7. Do you have the education/knowledge to run the business successfully?
Do you have the experience to run the business? If not, do you have a professional advisor that will show you how to be profitable/successful?
8. Does the activity earn a profit sometimes?
The IRS considers it profitable if you earned a profit (even a small one) at least 3 of the last 5 years.
9. Will you profit off the appreciation of assets used?
Did you include assets in the activity that may appreciate, such as land, or property?
If you answered ‘yes’ to most of these questions, you likely have a business, and if you answered ‘no’, you likely have a hobby.
If you can’t pass the profitability requirements (3 of the last 5 years with profits), check your records. Are you keeping careful track of revenues and expenses? Do you have a plan to increase profits? Check with an advisor to see what you can correct to win the battle between business vs hobby, giving yourself more tax benefits for your activities.