If you don’t make a profit, the IRS can determine your business is a hobby. If this happens, you will not be allowed to use your loss from the hobby to offset other income. This is usually an unfavorable result, so here are the ways to keep this from happening.
If you make a profit three of the last five years, you are considered to be carrying on the business for a profit. The IRS prefers your business to make income every year. If you lose money sometimes you are allowed to use the loss to lessen the taxes you pay on your other income.
Even if you are losing money, the IRS will still allow you to claim the income as business income if you meet the following tests. As always, keep good,organized records and these will help you if you get audited.
– Does your time and effort indicate an intention to make a profit?
– Do you depend on income from the activity?
– When losses occur, is it due to circumstances beyond your control or in the start-up phase?
– Have you changed methods of operation to improve profitability?
– Do you or your advisers have the knowledge to carry on the activity as a successful business?
– Have you made a profit in similar activities in the past?
– Have you made a profit in some years?
– Can you expect to make a profit in the future?
Generally, you must be carrying on the activity expecting to make income. Bloggers need to be careful because the IRS will try to classify your business as a hobby if you are not making money. So, you should be carrying on as a business. If your expenses exceed your income, maybe you should look at your intentions and see if you are carrying on as a hobby. If this is the case, it is best to start classifying your income and expenses this way to avoid penalties and interest.
Hobby income is entered on line 21 of the 1040. Then, you can deduct hobby expenses on your Schedule A. If you don’t have other items that make itemizing greater than the standard deduction, then you won’t get to claim any of your hobby expenses. And, you won’t ever be able to claim more expenses than income if your activity is a hobby.
This year, the Tax Court sided with the owner of a hair salon that claimed business losses instead of hobby loss. (Delia, TC Memo 2016-71, 4/20/16) The owner never reported a profit in the eight years she was in business. The IRS determined it to be a hobby and didn’t allow her to take expenses except on the Schedule A. She went to court and won. The taxpayer had very meticulous records of all income and expenses. The Tax Court determined the taxpayer had carried on her activity with the objective of making a profit. They also determined that she had taken reasonable steps to grow the business. The salon was also not a source of personal pleasure or a hobby.
If your business is not making a profit, it is important to evaluate your motives. Keep good records, make efforts to make a profit and keep your personal expenses separate. These are the best tips for continuing to be able to claim all of your expenses even when they are greater than your income.
Every taxpayer has a unique situation. So, it is always a good idea to seek help from a tax adviser whenever you have questions.