What’s in a word? A world of tax consequences when the word is “business” or “hobby.”
In a nutshell: If you and the IRS determine that an activity is a business, you’ll owe taxes on profits and will be allowed to deduct expenses for conducting that business. But if your passion for, say, making quilts is a “hobby,” you cannot deduct the fabric, thread, needles and labor needed to make the bedclothes.
Is your time-sapper really a business? Consider these criteria, and don’t try to blur the business-hobby lines, which could red-flag your return and trigger an audit.
The IRS presumes that an activity is pursued for profit if it made money in at least three of the past five tax years (including the current year). If your activity consists primarily of training, breeding, showing or racing horses, it’s considered a business if you posted profits in at least two of the past seven years.
Even with the above guidelines, the line between a hobby and a business isn’t always clear. The IRS may look at certain factors, such as, but not limited to, the following:
Of course, an activity can be a hobby and still produce income, and you can deduct hobby expenses to a certain extent. If your activity is a hobby, however, you cannot use losses to offset other income.
The differences between a hobby and a business can be subtle, so be sure to give us a call before drawing conclusions about whether your particular activity is a hobby or a business.