Understanding Home Business Deductions

Is it a Hobby or a Business?

Your business activity may be classified as a hobby by the IRS regardless of what you call it. The difference is as important to you as it is to the IRS. Many businesses will have an operating loss during a tax year. This loss is used to offset any income from other sources.  In contrast, a loss from a hobby is not deductible and cannot offset other sources of income.

Now here’s the irony. The full amount of your income for your hobby is considered as gross income. If you choose to itemize your deductions on Schedule A, your hobby expenses may be deductible, but only up to the amount of hobby revenue. The point is that you can NEVER have a hobby loss. In a business you CAN have a business loss.

Simply put, in a business you have income from sales and losses from expenses. The two offset or counter each other. In a hobby it’s usually one way to the IRS. Everything you make is taxable and everything you spend is your contribution to the hobby. NO deductions allowed unless you itemize. Hobbies are better if it’s biking or photography. As soon as you make money on the hobby, you pay taxes on it.

If you make money, consider going into business. Now consider that if you’re going to make $100 in a year there’s not much sense in being in business. The paper work will cost you more than you save. But if you plan on making more than a few thousand dollars, a business is probably the way to go.

Is It Really A Business?

The IRS distinction between a business and a hobby is critical. Remember that what you think does not matter.

The IRS distinguishes between a business and a hobby by the manner in which you conduct your business. Ask yourself the following questions:

1. Do you maintain accurate books and records?
2. How much time do you devote to operating the business?
3. Do you have the expectation that your assets used in the business will appreciate in value?
4. Do you have a history of success in other activities?
5. What is your history of income and losses in this activity?
6. How much profit, if any, has been earned?
7. Is this your only source of income?  (The IRS is more inclined to consider the activity a business if it is.)
8. Are there elements of personal pleasure or recreation involved?
9. Do you have a DBA (Doing Business As)?
10. Do you have a business checking account?
11. Do you have a business phone?

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