Are you sure your business isn’t considered a hobby in the eyes of the IRS? If so, then your expenses are very limited or disallowed. Here are some factors to help determine if you operate a business or hobby.
Factors According to the IRS
- The taxpayer carries out activity in a businesslike manner and maintains complete and accurate books and records.
- The taxpayer puts time and effort into the activity to show they intend to make it profitable.
- The taxpayer depends on income from the activity for their livelihood.
- The taxpayer has personal motives for carrying out the activity such as general enjoyment or relaxation.
- The taxpayer has enough income from other sources to fund the activity
- Losses are due to circumstances beyond the taxpayer’s control or are normal for the startup phase of their type of business.
- There is a change to methods of operation to improve profitability.
- Taxpayer and their advisor have the knowledge needed to carry out the activity as a successful business.
- The taxpayer was successful in making a profit in similar activities in the past.
- Activity makes a profit in some years and how much profit it makes.
- The taxpayer can expect to make a future profit from the appreciation of the assets used in the activity.
Safe Harbor According to the Code
There is a safe harbor rule stating if you have income from an activity for 3 or more years out of 5 then the activity is considered to be engaged in for profit.
Expenses not Deductible
The main reason you do not want an activity to be considered a hobby is because you cannot deduct any expenses, except for those directly tied to producing the product, such as materials and inventory.