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Businesses, Hobbies, and Taxes

October 06, 2014  |   Tax News   |   Tags: , ,  

These days, it’s becoming remarkably easy to make a little money doing something that a person usually enjoys as a hobby. For instance, a person who likes knitting can sell all sorts of creations on popular craft selling sites or even at street fairs. However, just because someone decides to make a little money on something they enjoy doesn’t mean that they are operating a business. In fact, the IRS views many activities as hobbies. This may not seem like a difference of opinion that matters, but it definitely makes a difference during tax time.

business income taxIn the same way that a person can claim fuel expenses for extensive travel related to his or her job as deduction, a business owner claims operation expenses (equipment, materials, advertising, etc) as deductions on their returns. However, most people understand that they cannot claim the plane tickets they bought for their vacation as a work-related deduction. So, when the IRS sees a return claiming knitting needles as a business expense, they want proof that this was not just a purchase made just for personal enjoyment.

This is why it is important to be completely certain that any money-making activity is a business before filing any returns with the IRS.

If a taxpayer can answer yes to the following questions the activity will probably be viewed as a business by the IRS.

  • Do I need the money I make from what I am doing?
  • Am I intending to make a profit from this activity?
  • Were my losses due to circumstances beyond my control or did they happen during the start-up phase when most businesses experience a loss?
  • Am I making changes to increase my profit?
  • Do I know how to make what I am doing a successful business or am I receiving advice from someone who does?
  • Have I made a profit before doing something similar?
  • Have I made a profit from what I am doing for at least 3 out of 5 years?
  • Can I make a profit from the appreciation on assets I use for what I am doing?

Simply answering “yes” to all of these questions may not be enough to convince the IRS that a taxpayer is running a business instead of enjoying a pleasant hobby. The burden of proof lies on the business owner. This means that extensive record keeping over a period of some years is necessary. It is usually recommended that businesses employ the help of a reputable accountant and tax professional, and situations like this are exactly why. It’s in the business owner’s best interest to have a tax professional when there is a doubt as to whether a business truly is a business.