Taxpayers may be faced with the question: “Is it a hobby or business?” The IRS states that: “sometimes the line between having a hobby and running a business can be confusing, but knowing the difference is important because hobbies and businesses are treated differently when it’s time to file a tax return. The biggest difference between the two is that businesses operate to make a profit while hobbies are for pleasure or recreation.” This means that a hobby is an activity that is not done to make a profit.
In addition, “whether someone is having fun with a hobby or running a business, if they accept more than $600 for goods and services using online marketplaces or payment apps, they could receive a Form 1099-K. Profits from the sale of goods, including personal items, and services is taxable income that must be reported on tax returns.”
How can a taxpayer distinguish between a Hobby or a Business? Taxpayers decide if it is a hobby or business according to the IRS
The IRS states that a taxpayer must take into account all the facts and circumstances in making the distinction between a hobby or business. These are the factors set forth by the IRS in determining whether an activity is a business engaged in making a profit:
- Whether you carry on the activity in a businesslike manner and maintain complete and accurate books and records.
- Whether you have personal motives in carrying on the activity.
- Whether the time and effort you put into the activity indicates 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 startup phase of your type of business).
- 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
What is a trade or business activity?
The answer to this is found in Commissioner v. Groetzinger, 480 U.S. 23 (1987), which states that: “to be engaged in a trade or business, the taxpayer must be involved in the activity with continuity and regularity, and that the taxpayer’s primary purpose for engaging in the activity must be for income or profit. A sporadic activity, a hobby, or an amusement diversion does not qualify.”
Taxpayers need to be cautious about their decision on hobby or business
If a taxpayer has a business, the business may be entitled to certain tax deductions. Taxpayers may be able to deduct ordinary and necessary expenses for running a business. However, there are no deductions for hobby expenses as per the IRS Publication 529 which states that: “A hobby isn’t a business because it isn’t carried on to make a profit. If you receive income for an activity that you don’t carry out to make a profit, the expenses you pay for the activity are miscellaneous itemized deductions and can no longer be deducted. You must still report the income you receive on your Schedule 1 (Form 1040)”.
Incorrect Deductions can raise a red flag for the IRS and trigger an audit
An IRS Audit is what is known as an impartial review to assess return filing accuracy. The IRS audits returns to determine if income, expenses, and/or credits are being reported accurately. If you are chosen for an IRS audit, it is best to arm yourself with information. Gathering and organizing your information is essential for understanding the process; understand why you were chosen to be audited; know what your responsibilities and rights are and know how to appeal IRS findings.
Know this
If you are unsure if you have a hobby or business, best to consult a specialized tax advisor.
Are you a taxpayer with a hobby or business?
Have you received any income from your hobby?
Who is your specialized tax advisor? ©
