Tax Facts

Hobby or Business?

So, you have a "side business" and it happens to be something you haven't made money on...yet.  Sure, you plan on making money someday.  But at the end of each year so far, your expenses turn out to be more than you took in.  If that goes on for too long, the IRS looks at your "side business" as really just a hobby and therefore subject to Hobby Loss rules.

Classifying what you do as a hobby really has little to do with what it is that you're doing - as long as it's legal, of course.  You could be making cupcakes or making cars; it doesn't matter.  What matters is the presumption of a profit-seeking motive. In other words, you are presumed to be engaged in an activity for profit if you can show a profit in at least three of the last five years, including the current year.

Don't get too excited about taking those losses, though.  The IRS may try to rebut your presumption based on the facts and circumstances.  You would then have to prove a profit motive by showing five things:

  1. spend considerable time in the activity
  2. that you keep businesslike records
  3. that you have a written business plan laying out your ideas and plans for making a profit
  4. that you relied on expert advice, and
  5. that the losses you have are actually common in your type of business

So, really, what is it?

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