Is This Business For Real? Or Is it a Hobby?

Hobby or Real Business? What are the Tax Laws?

woman sewing at kitchen table
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Summers are time for flea markets, craft sales, garage and yard sales, and other events where people sell household goods, food items, and products they have made. If you have only one such sale a year - a garage sale, maybe - you may be wondering if you can count these activities as a business. You can certainly have a hobby and deduct (limited) expenses for that hobby, but you can't file a tax return for that hobby as a business.

As you might expect, the IRS distinguishes between legitimate businesses and hobby activities, for the purpose of taxes. If you are legitimately in business, you can deduct the expenses of that business and possibly take a loss if your business isn't profitable. If you are engaging in a hobby, you cannot deduct expenses to get a loss to offset other income. The IRS calls this the "hobby loss" rule.

Is this activity a business or a hobby?

A legitimate business, according to the IRS:

  • Has a primary purpose of "income or profit" and
  • the activity is engaged in "with continuity and regularity."

The IRS has a set of guidelines to be used in determining whether an activity is a legitimate business or a hobby: 

  • Does the time and effort put into the activity indicate an intention to make a profit?

  • Does the taxpayer depend on income from the activity?

  • If there are losses, are they due to circumstances beyond the taxpayer’s control or did they occur in the start-up phase of the business?

  • Has the taxpayer changed methods of operation to improve profitability?

  • Does the taxpayer or his/her advisors have the knowledge needed to carry on the activity as a successful business?

  • Has the taxpayer made a profit in similar activities in the past?

  • Does the activity make a profit in some years?

  • Can the taxpayer expect to make a profit in the future from the appreciation of assets used in the activity?

    How do expenses get deducted for a business and a hobby?

    A business would file its taxes on a business tax return. For most small businesses, that means filing a Schedule C for business income. The net income from the business is then included on the individual's personal tax return. If your business is an LLC or partnership or S corporation, you would prepare a tax return for that business and take the resulting income over to your personal tax return.

    Expenses for hobby activities may be included with other itemized deductions on Schedule A, but you may not deduct expenses in excess of income. 

    How do I know if the IRS will consider my activity as a business or a hobby?

    There is no place where you designate the deductions from your activity as a business or hobby. It's the IRS that determines if your activity is a business or a hobby. This doesn't happen unless you get audited. So you want to be sure you can show that your activity meets the guidelines listed above.

    What about corporations? Can a corporation have a hobby loss?

    Because a corporation is a separate business entity, the IRS does not recognize the "hobby loss" rules for corporations. Because S corporation profits and losses are part of personal tax returns, the "hobby loss" rules do apply.

    My business is just starting. What if my business doesn't make a profit?

    If the business doesn't make a profit in the first few years, the other factors listed above may be considered in the determination of whether a business is a hobby.

    Intending to make a profit and being considered a legitimate business also includes good business practices such as:

    In addition to helping legitimize your business in the eyes of the IRS, these activities are important for every business.

    For more information, read this article with details from a recent Tax Court case about how a business that has not made a profit might still be considered a legitimate "for profit" business.