The IRS generally allows 5 years of business activity before questioning whether your activity is a business or a hobby. You must show a profit for at least three of the last five years, including the current year. There are exceptions to the basic rules.
If your business activity is not profitable, then it is considered; Non-profit and business losses cannot be used to offset your income.
To make this determination if your activity is a hobby or a business, ask yourself the following questions:
1. Does the time and effort you put into the activity indicate your intention to make a profit?
2. Do they depend on the income of the activity?
3. If there are losses, are they due to circumstances beyond your control or did they occur in the start-up phase of the business?
4. Have you changed operating methods to improve profitability?
5. Are you qualified to run / operate the activity, or do you have advisers who have the necessary knowledge to run the activity as a successful business?
6. Have you made a profit from similar activities in the past?
7. Does your activity generate profits in a few years?
8. Can you expect to make a profit in the future from the appreciation of the assets used in your business?
If you answer “yes” to the questions above, you most likely have a valid business and not a hobby. If you are unsure, you should contact your tax professional. Each of these points has additional legal jargon attached, for legal tax codes go to: irs.gov and read Publication 535, Business Expenses.
If you have a valid business, report your income on Schedule C. If you have a hobby, report your activities on Schedule A, with limitations.
There are companies that sell home businesses as a legal tax deduction. Before making such an investment, remember question number five. Are you qualified to run / operate the activity or do you have advisers who have the necessary knowledge to carry out the activity as a successful business?
Again, the IRS assumes that an activity is conducted for profit if it makes a profit for at least three of the last five tax years, including the current year.