Hobby or Business? IRS Reminds Taxpayers of the Differences

Hobby or Business? IRS Reminds Taxpayers of the Differences

IRS issues fact sheet regarding hobby loss rules

Did you know? Activities that appear to involve an element of personal enrichment or recreation may be subject to IRS scrutiny. This does not necessarily mean that you cannot deduct expenses for an activity you enjoy, but you must be prepared to show that the activity is a business from which you intend to make money.

The IRS recently issued a fact sheet on this topic: Know the difference between a hobby and a business.

This article summarizes this IRS fact sheet.

Evaluating whether an activity is a hobby or a business

The IRS provides some key questions to help determine if your activity is classified as a hobby or business.

• Is the activity conducted as a business?
• Does the taxpayer have expertise in the activity?
• Is the activity the main source of income for the taxpayer?
• Does the taxpayer expect to make a profit?
• Is the activity profitable in some years?

When evaluating an activity, if the answer is yes to these five questions, it is likely a business. However, the most powerful determining factor is profit motive. To show an activity is engaged in for profit, the activity’s gross income must exceed its deductions in three out of five consecutive tax years. If the activity does not meet these guidelines, it could be subject to hobby loss rules.

Effect of Tax Cuts and Jobs Act on hobby loss deductions

Determining whether an activity is a business or hobby became more important when the Tax Cuts and Jobs Act (TCJA) became effective in 2018.

TCJA suspended miscellaneous deductions for hobby expenses in the years 2018-2025. The inability of a taxpayer to deduct even a portion of the hobby expenses while recognizing all hobby income makes establishing a profit motive for a hobby activity even more desirable.

Conclusion

Encouraging taxpayers to produce profits results in more revenue for the IRS. Activities enjoyed for emotional or spiritual or intellectual -- rather than fiscal -- improvement, are much more likely to produce expenses rather than profit. If all such expenses were deductible, it would result in decreased revenue to the IRS. Not surprisingly, then, the IRS does not hesitate to disallow deductions that it concludes result in "hobby losses."
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Article provided by Annika McKinney.