Tuesday, June 5, 2012

Hobby Loss vs. Business Deduction Factors

What factors differentiate a hobby from an active business for tax purposes? 

§ 183 of the internal revenue codes says that to be deductible, activities must be motivated by profit. There are many important factors that differentiate a hobby from a business include: 

  • Look at the manner in which the taxpayer carried out the activity. Are they seriously and regularly trying to make a profit?
  • What is the expertise of the taxpayer and the advisors? Is there expertise in doing the activity? Previous experience in doing the activity.
  • Time and Effort the taxpayer has put into the activity.
  • Any expectation that the assets used in the activity might appreciate in value.
  • The success of the taxpayer carrying out similar activities in the past.
  • The taxpayer’s history of income and loss in regards to the activity. This is a backward looking factor to examine how good they were in the past. You do not need to show a profit every year. It is helpful to show improvement over several years to indicate that they are trying. TRAJECTORY 
  • The amount of profit in the current year. Current state of the business.
  • Financial Status of the taxpayer. Is the taxpayer financially dependent on this particular activity?
  • Any elements of personal pleasure or recreation. They will have harder time showing that something fun is an activity engaged in for profit. 
If a taxpayer is merely engaged in a hobby, they will not be able to deduct any hobby losses on their tax returns. 

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