Is Your Business a Hobby?

​Do you have an activity that you do on the side that you think of as a business? Are you claiming losses on your personal tax return (Schedule C, Form 1040)? Will the IRS allow those losses?

I have had a few questions lately about what the IRS considers to be a hobby and what it considers to be a business. If a business, losses are deductible. If a hobby, you can only deduct expenses up to your revenue and therefore are unable to deduct a loss.

The IRS likes to claim that money-losing sideline activities are hobbies rather than businesses. The federal income tax rules for hobbies have been anti-taxpayer for years, and an unfavorable change enacted in the Tax Cuts and Jobs Act (TCJA) made things even worse for 2018-2025.

If you have such an activity, I should have your attention.

Here’s the deal: if you can show a profit motive for your now-money-losing sideline activity, you can classify that activity as a business for tax purposes and deduct the losses. If you can't, you don't get to deduct the losses.

Factors that can prove (or disprove) such for-profit intent include:

• Conducting the activity in a business-like manner by keeping good records and searching for profit-making strategies.
• Having expertise in the activity or hiring advisors who do.
• Spending enough time to justify the notion that the activity is a business and not just a hobby.
• Expectation of asset appreciation: this is why the IRS will almost never claim that owning rental real estate is a hobby, even when tax losses are incurred year after year.
• Success in other ventures, which indicates that you have business acumen.
• The history and magnitude of income and losses from the activity: occasional large profits hold more weight than more frequent small profits, and losses caused by unusual events or just plain bad luck are more justifiable than ongoing losses that only a hobbyist would be willing to accept.
• Your financial status: “rich” folks can afford to absorb ongoing losses (which may indicate a hobby), while ordinary folks are usually trying to make a buck (which indicates a business).
• Elements of personal pleasure: breeding race horses is lots more fun than draining septic tanks, so the IRS is far more likely to claim the former is a hobby if losses start showing up on your tax returns.

The IRS starts looking at these activities when losses are deducted on a consistent basis (more than three out of the last five years).

If you have a loss-producing activity that you consider a business but the IRS might consider a hobby, it would be wise to firm up your supporting factors to make sure that it looks and smells more like a business than a hobby.