Millions of people have hobbies, but when your favorite hobby starts to turn a profit, the IRS may consider it a business. What is the difference?
The IRS defines a hobby as any activity not pursued for profit, whereas a business is defined as any activity done with the reasonable expectation of earning a profit. It is important for taxpayers to determine whether the activity engaged in is for profit as a business or is just a hobby for personal enjoyment.
The tax considerations are different for each activity. You are required to report and pay tax on income from almost all sources, including hobbies. Yet, when it comes to deductions such as expenses and losses, hobbies and business differ in their tax implications.
Hobby vs. Business?
If you’re not sure whether you’re running a business or simply enjoying a hobby, here are some of the factors you should consider:
- Is your time and effort put into the activity with the intention of making a profit?
- Are you depending on income from the activity?
- Have operations changed to improve profitability?
- In the past, have you made a profit in similar activities?
- Have some of the years’ activities resulted in a profit?
- Are you expecting to make a future profit due to asset appreciation used in the activity?
- If the activity resulted in losses, are the losses due to circumstances beyond your control or are the losses from the startup of the business?
The IRS’ primary test for the activities’ determination of hobby or business is called a “profit test.” The activity is presumed for profit when the activity results in a profit in at least 3 of the previous 5 years (includes current tax year).
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