Accounting & Auditing Blog

Business or Hobby? Nine factors that determine your classification

I have worked with many business owners over the years that are always showing losses on their tax returns, year in and year out.  Every time I see these kind of results, I bring up the IRS and the "hobby loss" rules (Section 183 of the IRS Code). The IRS and their flagging systems easily detects this activity and word on the street is they are targeting the improper reporting of hobby losses on business owner's tax returns.  

When an IRS agent is reviewing your business and whether or not it is a hobby for tax purposes, they look at these nine factors:

  1. How the taxpayer carries on the activity.
  2. The taxpayer's expertise in this activity.
  3. How much time and effort the taxpayer is spending carrying out this activity.
  4. An expectation that assets used in an activity, such as land, may appreciate in value.
  5. The taxpayer's success in other activities.
  6. The taxpayer's history of income or losses from the activity.
  7. The relative amounts of profits and losses.
  8. The taxpayer's financial status.
  9. Whether the activity provides recreation or involves "personal motives".

The impact of the IRS reclassifying a business to a hobby can be HUGE.  If your business is determined to be a hobby, you are required to report all income from that activity as "Other Income".  The expenses from this activity is then reported as Miscellaneous Itemized Deductions, subject to the 2%-of-AGI Floor.

As business owners, for this reason and other obvious reasons, it is not a positive to be showing negatives on your tax returns as you report your business activities. Call us at 440-449-6800 or visit our tax planning and preparation website – we'll help you develop a balanced, compliant and personalized approach to doing business. To read more tax related articles by our staff, visit our blog page here.

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