It seems like everyone is saying they have a business nowadays, but does the IRS agree with you?
Well, why does it matter?
It matters because, with a business, you can use business losses to offset your income when filing taxes. With a hobby, you cannot deduct more than you have earned. You also can’t claim negative hobby income on your taxes. —> Hobby Loss Rule
Many legit businesses start out with a loss their first few years, but the IRS expects that you set up your business with a plan to make a profit. Then there are those individuals that just set up their business, but they are really just hobbies, in order to claim expenses and losses on their taxes. The IRS frowns on the latter of course. In order to prevent the IRS from considering your business a hobby, check out these guidelines straight from their website:
- Does the time and effort put into the activity indicate an intention to make a profit?
- Does the taxpayer depend on income from the activity?
- If there are losses, are they due to circumstances beyond the taxpayer’s control or did they occur in the start-up phase of the business?
- Has the taxpayer changed methods of operation to improve profitability?
- Does the taxpayer or his/her advisors have the knowledge needed to carry on the activity as a successful business?
- Has the taxpayer made a profit in similar activities in the past?
- Does the activity make a profit in some years?
- Can the taxpayer expect to make a profit in the future from the appreciation of assets used in the activity?
Are you nervous that the IRS may consider your business a hobby?
Well then let’s take some steps to Audit-Proof your business:
- Register your business with your state as an LLC or Corporation.
- Keep your business and personal expenses separate.
- Keep good business records.
- Maintain a business website, business email and business hours.
- Comply with state and federal tax laws. (and pay your sales taxes!!!)
These activities are important for EVERY business!
In sum, if you plan on running a business, be sure you’re operating it as a legit business. This will save you the stress of a lengthy audit.