When starting a new business you need to ask yourself, is this new venture truly a business, or just a hobby? Although millions of Americans can generate income from their hobbies, the IRS has provided some guidelines to help taxpayers determine if that income is in fact from a business or a hobby. One of the main goals of a business is to make a profit, and it is possible to generate income from your hobby without making a profit.
The IRS has listed 9 factors to help taxpayers determine if their activity is a business or a hobby:
- Do you maintain complete and accurate books, and do you conduct your activity in a businesslike manner?
- Do you have personal motives when conducting your activity?
- Do you put enough time and effort into the activity to prove that you intend to make a profit?
- Do you depend on the income from your activity for your livelihood?
- Are losses due to circumstances beyond your control? For example, are they considered normal in the startup phase of your business?
- Do you have advisors with the knowledge needed to conduct a successful business?
- Have you been successful in making a profit from this activity in the past?
- Have you made a profit in previous years and how much of a profit does your activity make?
- Do you expect to make a future profit from the appreciation of the assets used in the activity?
These factors are not definitive but are meant to help taxpayers determine whether the activity they are engaged in is a business or a hobby. If your business has operating losses for more than 2 out of 5 years (5 out of 7 years for horse racing, breeding, or showing) then the IRS can reclassify it as a hobby. Under the Tax Cuts and Jobs Act of 2017 (TCJA), taxpayers can no longer deduct expenses related to a hobby; however, they must still report the income received from that hobby as Other Income on line 21 of Schedule 1, Form 1040.