Is This Activity A Business Or A Hobby?

In order for an expense to be tax deductible, you must incur it for a business, and not for a hobby. 

It you want to deduct an expense, the IRS will apply a Facts and Circumstances Test to answer the question "Is this activity a business, or a hobby?" If it's a hobby, it's not deductible. If you can show the IRS your intention to make a profit, you have a business. It's up to you to be able to prove it. If you have any fun at the activity you want to declare a business, you may have a problem. You need facts and circumstances that support your intent to make a profit. 

How the IRS answers the question "What is a business?" relates to several court rulings. 

A professor, in his spare time, gave motivational speeches. He didn't make a lot of money. In fact, he lost money. In his audit, the IRS ruled that his expenses weren't deductible because speaking was a hobby-he enjoyed doing it. The Professor said, "You're kidding me. I can't enjoy what I do?" The court reversed the IRS' decision and ruled in the professor's favor. 

Another man bought a piece of property that didn't turn a profit for 26 years. The IRS wanted to deem his expenses a hobby loss. But the service had a problem. In year 27, the landowner sold his property for $3,000,000 more than he paid for it. When the owner went to court his attorney said, "Isn't the intent of a business to make a profit?" Since clearly he had made a profit, he won. 

If you lose money for an extended period of time, and you intend to make a profit, you can still deduct your expenses. Many people believe that if you're a sole proprietor, you must make money in at least two of five years, or you will send a red flag to the IRS. This is a myth. You can lose money for many years without sending a red flag to the IRS. 

There are many activities that support your intent to make a profit. Here are a few: 

  1. Keep clear records of expenses and their purposes
  2. Generate income
  3. Incorporate your business
  4. Hire an employee

Whether or not you make money, if you can show the service you intended to make a profit, you can successfully deduct your expenses. 

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