Business or Hobby?

April 13, 2006

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In order to be treated as running a business for IRS purposes, and to be able to deduct your business expenses, set up a retirement plan, and claim other tax breaks allowed to business owners, you must be engaged in a "trade or business." A profit motive must be present (though you may in fact have experienced a loss) and some type of economic activity must be conducted. This profit motive separates a business from a hobby, which is an activity engaged in purely for self-satisfaction.

"Profit" for purposes of the business activity rules means real economic profit, independent of any tax savings.

You may qualify for a presumption that you had a profit motive.
Or, you can establish the profit motive of your business under the nine factors used by the IRS.
Hobby loss rules kick in if you are unable to prove that you're engaged in a business activity under either of these two methods.

To be deductible, business expenses must be incurred in carrying on an existing trade or business. Costs associated with starting up a business, that are incurred before the business begins to operate, are considered capital expenditures, which are not fully deductible as current expenses.