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Is Your Activity A Business or A Hobby?

Earlier in the week, our Facebook account posted a really interesting article from Forbes about the Olympics and taxation. You can view that article here: Facebook Article . By the way, if you are not already following us on Facebook, please give us a “like”!

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The article references how Olympic athletes are taxed and how it depends on if they treat their participation as a business or as a hobby. The IRS has strict rules to distinguish what is a hobby and what is a business. They regularly monitor Schedule C’s that are submitted to verify that they are indeed a business activity.

So, What Does The IRS Consider A Hobby Vs. A Business?

Per the IRS tax code, here are some things to consider when determining if you are participating in a business or a hobby:

  • Does the time and effort put into the activity indicate an intention to make a profit?
  • Does the taxpayer depend on income from the activity?
  • If there are losses, are they due to circumstances beyond the taxpayer’s control or did they occur in the start-up phase of the business?
  • Has the taxpayer changed methods of operation to improve profitability?
  • Does the taxpayer or his/her advisors have the knowledge needed to carry on the activity as a successful business?
  • Has the taxpayer made a profit in similar activities in the past?
  • Does the activity make a profit in some years?
  • Can the taxpayer expect to make a profit in the future from the appreciation of assets used in the activity?

As a rule of thumb, the IRS considers an activity is being carried on for profit if it makes a profit during at least three of the last five tax years, including the current year — at least two of the last seven years for activities that consist primarily of breeding, showing, training or racing horses.

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What Is The Difference In Taxation Between A Business And A Hobby?

If you determine that your activity is a business, then you will report all of your income and expenses involved on the Schedule C. On the other hand, if your activity is considered a hobby, you will report your income as “Other Income” and your expenses will only be deductible along with your other itemized deductions on the Schedule A.

Business vs. Hobby is a section of the tax code that the IRS audits frequently, and for good reason. Incorrect deductions of hobby expenses account for a portion of the overstated adjustments, deductions, exemptions and credits that add up to $30 billion per year in unpaid taxes, according to IRS estimates.

We help business owners in Milwaukee, Waukesha, Brookfield, New Berlin, Wauwatosa with business tax return preparation and tax planning.

If you are currently doing any side projects, or are considering starting one up, please contact your tax guy at Hammernik & Associates to determine if it is a business or a hobby. Your tax planning strategy may depend on it!

 

Until next time,

Nicholas Hammernik, EA

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