Business v. Hobby By Emilee Traylor

Have you recently started a side business? Or are you thinking about turning a hobby into a side business? Well there are a few things you need to know regarding your taxes. If your business claims a net loss for too many years the IRS may classify it as a hobby, which would prevent you from claiming a loss related to the business. Before the new tax law if your business was considered a hobby you were still able to take the loss as an itemized deduction on your personal tax return. Under the new law you can no longer take a hobby loss as a deduction on your personal return because the new law eliminated the miscellaneous itemized tax deductions.

Here is how to make sure your side business is ran like a business and not in jeopardy of being classified as a hobby.

  1. Have yearly financial statements prepared.
  2. Have profit for 3+ years within a consecutive 5 years.
    • Now if you don’t meet this guideline you have the option to file an election to postpone their determination for 5 years, BUT this is not a good idea. If you file this election you are calling more attention to your business
  3. Now you still have another option if you don’t file this election. It’s called the Facts and Circumstances Test. Here is the criteria:
  4. Honest attempt to make money
  5. Have a business plan
  6. Watch what you say (Never say you don’t intend to make money!)
  7. Manner of business conduct
  8. Keep Records (Keep your books separate! Personal accounts and Business accounts)
  9. Run your business like a profitable business
  10. Prior Experiences
  11. Thoroughly investigate similar businesses prior to starting a new venture.
  12. Consult experts
  13. The more time and effort you put into your business.
  14. Watch excessive expenses
  15. History – Did you consult experts? Did you have an annual review?

Not all of these factors need to be met for the IRS to classify you as a business, BUT you do need to pay attention to them a key in on several and make sure you have supporting documents. The IRS wants you to be in business, but they want you to be making an honest attempt to make money.

If you are thinking about starting a side business and need help with any of the topics listed above reach out to your local bookkeeper, financial advisor or CPA. All of these people can help you start off on the right foot.

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