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:
- 9Keep clear records of expenses and their purposes
- 9Generate income
- 9Incorporate your business
- 9Hire an employee