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Does the IRS See Your Business as a Business?


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One of the reasons many people decide to turn their business into a hobby is to claim the expenses on their taxes. While this is a smart thing to do, don’t just assume that the IRS will always see your business as a business.


The fact is if the IRS doesn’t believe your business is an actual business, they can prevent you from claiming those expenses. So, knowing whether the IRS sees your business as a business would entail understanding how the IRS classifies a business.


The first thing you want to do is understand the difference between a hobby and a business. Once you’ve done that, it’s important to understand what you need to do to keep that business designated as an actual business.


The Difference Between a Hobby and a Business

The main difference between a hobby and a business in the eyes of the IRS is that a business is a profit-generating entity, while the activities associated with a hobby are not to generate a profit. According to the IRS, a legitimate business’s primary objective is to make a profit, and therefore, is engaged in income-generating activities on a regular basis.


Typically, if your business has made a profit in at least three of the last five consecutive years, the IRS will presume that you are engaged in the activities to earn a profit.


What Happens if the IRS Classifies Your Business as a Hobby?

If the IRS classifies your business as a hobby, it won’t allow you to deduct any of those expenses on your taxes or take any loss for it on your tax return. Beginning with the 2018 tax year, the Tax Cuts and Jobs Act eliminated the ability of hobbyists to deduct non-business expenses as miscellaneous expenses on Schedule A of Form 1040.


How The IRS Classifies Your Business

The IRS has nine factors they use to determine whether the activities of a business qualify it as a legitimate business or a hobby:

  1. Business records: What type of business records does your business keep? Do you have an active business checking account? Do you run your activities as a business?

  2. Time Spent: How much time do you spend doing income-generating tasks? How much time do you spend marketing your business? What are you doing on a regular basis to draw customers to your business?

  3. Income: Do you depend on the income from your business to live?

  4. Business Losses: Are your business losses beyond your control or typical startup losses?

  5. Strategies: What types of strategies are you using to run your business: Have you applied different methods to get a better outcome?

  6. Experience: Are you qualified or have the experience to actually run your business? Are you engaging with mentors regularly or have advisors to turn to for help?

  7. Past Success: How successful have you been with past endeavors?

  8. Is it Profitable: Are you making a profit from your business?

  9. Does the activity lead to profit: Can you expect to make a profit on assets used in the activity in the future?

How to Keep Your Business Classified As a Business

If you have a legitimate business and want to ensure the IRS classifies it as such, here are some tips to help that to happen:

  • Properly register your business within your state with the appropriate business entity.

  • Make sure to have a separate business account in your business name.

  • Keep business and personal expenses separate.

  • Keep records of your business.

  • Comply with other state laws, such as collecting sales taxes and paying annual state business renewal fees or franchise taxes.

  • Keep regular business hours.

  • Regularly do profit-generating tasks that can earn you income and profit.

Conclusion

Hopefully, this information was helpful. If you’ve been wanting to turn your hobby into a business, but haven’t taken the proper steps, continue to look to SiMMs blog for help with your business. Looking to start an LLC? Look here.


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