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Taxation 101: Business Or Hobby?
Article by Elena Fawkner

Time and Effort Invested

Is your business a sideline or something you pursue more or less full-time? Obviously if you devote substantially all of your available time to the activity, the more likely it is that you have a profit motive since that is your primary source of income. Things can be trickier if you work full-time and your business is something you pursue on the side. Just be sure you can demonstrate an ability to devote substantial time and effort to your business. Unlike a hobby, a real business in which you have a profit motive demands time and effort. It's NOT something you just don't get around to this week because "things came up". With a hobby you can do that. With a business you can't.

Track Record of Profit-Making Ventures

If you have a history of involvement in profit-making activities in the past, this will be relevant to your ability to make a profit in your current venture. Conversely, if you have no track record at all of involvement in profit-motivated pursuits, the IRS is going to be looking for evidence that you know what you're about and have sufficient experience and expertise to turn your activity into a profitable sideline.

Nature of Losses

The nature of the losses you claim will also be a relevant consideration. If you're a start-up, substantial first year losses are to be expected. After that, however, you should be demonstrating a shift towards profitability. Your second year may still show a loss but it should be a smaller one that your first and your third should be smaller again than that, and so on.

Changes in Operations

If you continue doing things the same way, day in day out even when they're clearly not working to make you a profit, that's a strong indication that you're engaging in a hobby and that you don't have a profit motive. On the other hand, if you can demonstrate changes in operations to attempt to fix what isn't working for you, this will lean towards a profit motive.

Profit Patterns

The IRS will also be looking for profits in some years, even if losses occur in others. A pattern of small profits and large losses every year, year in, year out will raise suspicion.

This is just a sampling of the types of factors the IRS will give weight to in adjudging whether your "business" is truly a business or a hobby. For more information, visit the IRS website at http://www.irs.gov.

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