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How Does the IRS Decide If You Have a Business or a Hobby?

Have you ever gotten hired to cater a friend or family member's wedding?

Do you provide graphic design services, where you offer flyers, letterheads, or logo designs?

...or do you sell a handmade product online or during special events?

We honestly wouldn’t be surprised if you told us you had one or multiple side hustles. With the rise of inflation and the cost of living, a lot of people are looking for ways to supplement their income and do so by providing a service or sometimes a product. Making more money also poses the question of whether or not you have to file this additional income on your taxes and if you can deduct business-related or hobby-related expenses. Here, we’ll discuss the nine factors that distinguish between whether or not you have a business or a hobby.

What's Your Intent?

You have a business if your intent is to make a profit. Hobby activities are considered not for profit. Small business owners can deduct ordinary and necessary business expenses in full whereas with a hobby, the IRS won't allow you to deduct any expenses or take any loss for it on your tax return. As of 2018, hobby income cannot be deducted as a miscellaneous expense.

How Does the IRS Distinguish Between a Business and a Hobby Activity?

The IRS assesses each situation on a case-by-case basis but uses the following factors to determine whether your business activity is considered a business or a hobby:

  1. Whether you carry on the activity in a businesslike manner and maintain complete and accurate books and records.

  2. Whether you have personal motives in carrying on the activity.

  3. Whether the time and effort you put into the activity indicate you intend to make it profitable.

  4. Whether you depend on income from the activity for your livelihood.

  5. Whether your losses are due to circumstances beyond your control (or are normal in the start-up phase of your type of business).

  6. Whether you or your advisors have the knowledge needed to carry on the activity as a successful business.

  7. Whether you were successful in making a profit in similar activities in the past.

  8. Whether the activity makes a profit in some years and how much profit it makes.

  9. Whether you can expect to make a future profit from the appreciation of the assets used in the activity.

If your goal is to establish yourself as a business, make sure that you keep up-to-date documentation and receipts to establish your intent. Tax Incorporated can handle all of your back-office accounting work and tax filing. We offer a virtual streamlined process with the goal of helping you to manage your business finances better, keep your data safe, and provide financial advice to level up your business.

For more information, schedule a consultation with us today.

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