Business Vs. Hobby Guidelines

We have alluded in past articles to IRS guidelines in differentiating a personally owned business from a hobby. In this article, we will look more broadly at those guidelines. In order to avoid any perception of us giving legal or financial advice in these articles, we encourage you to click on the reference at the end of this article for more specific information on these guidelines. Our intent is to provide you with a few reminders to help you in setting up a new business and filing your taxes. Failing to regard these reminders can open you up to investigation and penalties from the IRS.

The areas that the IRS looks at in differentiating a business from a hobby are as follows:

  1. Are you carrying on the activity in a businesslike manner and do you keep complete and accurate books?
  2. Do you have personal motives in carrying on the activity?
  3. Do your time and effort in the activity indicating that you have intent to make it profitable?
  4. Do you depend on the activity’s income in making your living?
  5. Are any losses due to circumstances that are beyond your control, or normal startup phase losses?
  6. Do you or your business associates have the needed knowledge to make the activity a successful business?
  7. Were you successful in making a profit in similar activities in the past?
  8. Does the activity make a profit during some years, and how much profit does it make?
  9. Does the activity own assets that can be expected to make a future profit?

So, here are a few suggestions of things to think about in starting or managing your personal business:

  1. While personal satisfaction is always important to business success, your primary objective should be to provide services or products to other people. Your business must exist to give value to others first, and from this you will derive your income.
  2. Do you work with accountants, attorneys, bookkeepers, or other legitimate advisors to make sure that your business activities are legitimate, and that complete records of income and expenses are being kept and tax returns are filed as required by law?
  3. Do you and your employees or contractors dedicate sufficient and regular hours to show intent to make it profitable? Do you have written records of this activity and accompanying expenses?
  4. In your first years of business, can you show that any losses are a result of startup and attempting to build momentum and success? The IRS realizes that your most productive years in business will probably not be your first two years, and business loss is more easily acceptable to them at the beginning as long as your activities show genuine attempt to start earning profits.
  5. Do you need income from this business to become part of your livelihood either now or in the future?
  6. Are you studying and investing your time and money into learning how to better run this activity as a business to produce income?
  7. Do you have marketing and sales activities and expenses as a part of the regular operation of your business? All businesses must do marketing and sales to generate leads and revenue, make sure that these are a regular part of your business activities.

We want you to be able to create and build a successful business. It helps the general economy of this country and the world for you to do so. We strongly encourage you to bring in the right financial advisors, and to set up your business activities to create success. Learn more fully about the IRS guidelines by following the link below and dedicate yourself to making sure that your business really is a business and not a hobby, and that you are claiming all of the legitimate business deductions that apply to your business.

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i https://www.irs.gov/faqs/small-business-self-employed-other-business/income-expenses/income-expenses

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