Do You Have a Hobby or a Business?

Monday, August 15, 2022 – This is an age-old question, and it’s more than academic: The answer can mean a big difference in your tax bill. The following IRS guidance can help you make the right decisions and provide the right documentation at tax time.

Do you collect stamps? Write stories? Craft macrame holders for hanging plants? Are these hobbies or actual businesses? The IRS has weighed in on this: “A hobby is any activity that a person pursues because they enjoy it and with no intention of making a profit. People operate a business with the intention of making a profit.” Of course, acknowledges the agency, you may engage in hobby activities that turn into a source of income.

However, determining whether that hobby has grown into a business can be confusing. To help simplify things, the IRS has established factors taxpayers must consider when determining whether their activity is a business or a hobby.

These factors are whether:

• The taxpayer carries out activity in a businesslike manner and maintains complete and accurate books and records.
• The taxpayer puts time and effort into the activity to show they intend to make it profitable.
• The taxpayer depends on income from the activity for their livelihood.
• The taxpayer has personal motives for carrying out the activity such as general enjoyment or relaxation.
• The taxpayer has enough income from other sources to fund the activity.
• Losses are due to circumstances beyond the taxpayer’s control or are normal for the startup phase of their type of business.
• There is a change to methods of operation to improve profitability.
• The taxpayer and his or her adviser have the knowledge needed to carry out the activity as a successful business.
• The taxpayer was successful in making a profit in similar activities in the past.
• The activity makes a profit in some years, and how much profit it makes.
• The taxpayer can expect to make a future profit from the appreciation of the assets used in the activity.

All factors, facts and circumstances with respect to the activity must be considered. No one factor is more important than another.

In most situations, the IRS will grant a “safe harbor” and approve an activity as a business if it has turned a profit in at least three of five consecutive years.

What if a taxpayer gets lucky and starts making a profit from an activity that was never intended to do so? The IRS has that covered too: If a taxpayer receives income from an activity that is carried on with no intention of making a profit, the taxpayer must report the income he or she receives.

If you’re not sure about your situation, consult with a qualified tax professional.