Is This Really a Business?

Small home-based businesses have been touted as the last great opportunity for tax shelter. Maybe they are, but there are rules requiring that your business actually be a business and not merely a hobby for which you bring in a little cash to help cover costs.

Hobby Loss Rules

A Hobby Loss is a loss incurred in an activity that has some appearance of being a business, but which the taxpayer is not engaged in for profit. If an activity is deemed by the IRS to be a hobby, then deductions are only allowed to the extent of gross receipts. In other words, you cannot deduct a loss against other categories of income.

If a taxpayer engages in two or more activities, the costs incurred must be allocated among the activities in a rational manner that is consistently applied.

Presumption of a Profit

The good news is that an activity that generates a profit is presumed to be a business and not a hobby. To qualify under this standard, the activity must have generated a profit in three of the preceding five tax years.

Factors Listed in Regulations

The regulations list 9 factors to consider in determining whether an activity is engaged in for profit:

1. The manner in which the taxpayer conducts the activity
2. The expertise of the taxpayer or his advisors
3. The time and effort spent on the activity
4. The expectation that assets used in the activity may appreciate
5. The taxpayer’s success in similar activities
6. The taxpayer’s history of income or losses in the activity
7. The amount of profits
8. The taxpayer’s finances
9. Elements of personal pleasure or recreation associated with the activity

Ways to Reinforce Your Position

• Prepare a comprehensive business plan
• Always refer to your business in ways that reflect your profit objective
• Keep books of the type that a for-profit business would keep
• Carry out promotional activities aimed at generating growth
• Seek to improve your knowledge of the business
• Spend a reasonable amount of time working the business

Activities Often Targeted as Hobbies

• Collecting antiques, coins, stamps, etc.
• Raising thoroughbred dogs and horses
• Publishing pamphlets in philosophy
• Travel writing
• Auto racing
• Ministry
• Farming

The above activities can be engaged in for a profit, but when the taxpayer has other sources of income, these look particularly suspicious.