Many people have begun a hobby for fun, but it has turned into a business. I have helped several clients who started out using their product or service for family and friends and demand from others grew. So how do you know if your hobby is really a business?
The IRS has guidelines that determine if what you are doing is for fun or is really a business that needs a schedule C to be filed with your tax return. 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.
The following factors, although not all inclusive, may help you to determine whether your activity is an activity engaged in for profit or a hobby:
- 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 start-up 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.
An activity is presumed for profit if it makes a profit in at least three of the last five tax years, including the current year (or at least two of the last seven years for activities that consist primarily of breeding, showing, training or racing horses).
It is important to determine if your activity is a hobby or a business in order to know whether to use a schedule C (business) or schedule A (hobby).
If based on the above factors you determine your activity is really a hobby, you may still be able to write off expenses incurred (up to the point of any income received). In our next blog, we’ll discuss how to do so.
