Is your business considered a hobby by the Internal Revenue Service? One of the key questions or issues is whether or not your business is an activity engaged in for profit. While you may feel your business is established and engaged in for a profit, the IRS may feel otherwise, and the Internal Revenue Code can impact your deductions. This article has been prepared by a tax attorney to provide additional information regarding this issue. Please consult with your tax advisors or tax attorney regarding any questions you have.
The pertinent section relating to activities engaged in for profit is section 183, which is often referred to as the “Hobby Loss Rule.” IRC Section 183 limits deductions that a business may anticipate they can claim when the business is not engaged for a profit. As a business owner you can deduct ordinary and business expenses when conducting your business activity. However, if your business activity is deemed to not be engaged in for the production of income (a profit), you may not be able to deduct some or all of the expenses.
The IRS will consider certain facts and circumstances when determining whether your activity or business is a hobby, or an activity engaged in for profit. Some of these issues are stated below.
- Do you depend upon the income? Do you rely upon the activity or business to provide income that supports you?
- What amount of effort and time do you put into the activity, and does the amount of time and effort show you intended to make a profit?
- What is your knowledge base in regards to the activity and does such knowledge provide you with the ability to make a profit?
- Have you been successful in making a profit with the applicable activity or a like activity in the past?
- Has the activity made a profit in some of the taxable periods?
- What actions or methods have you implemented to improve profit or allow the activity to be profitable?
- If the activity has sustained losses, are the losses explained by circumstances beyond the taxpayer’s control?
- If the activity has sustained losses, are the losses due to reasonable or anticipated start up expenses?
If an activity makes a profit in at least three of the last five years, then the IRS should validate the business as an activity engaged in for profit. If the activity is deemed a hobby (not for profit), the losses from the activity cannot be used to offset other income. In short, the activity cannot produce a loss. Thus, the allowable deductions and expenses for the activity cannot exceed the gross income (gross receipts) of the activity.
If you have questions related to your business income, deductions and related matters, speak with a tax attorney at The McGuire Law Firm. Free consultation with a tax attorney in Denver or Golden Colorado.