Is Your Hobby a Business?

Bonnie Lee clarified at instances when what a taxpayer spends for his or her hobby can be written off as an expense.  During this economic downturn, many small business owners turn their hobbies into businesses.  In such a case, Lee said you can “write off expenses in excess of sales and enjoy a loss against other income on your tax return thus reducing your tax liability”. Should you be facing an audit, be prepared to prove that your hobby has turned into a business venture.  If you cannot handle the audit yourself, it is time to seek the help of a tax professional.

Many taxpayers have hobbies that earn a bit of income and the IRS states that in such cases, expenses can be written off only to the extent of sales. A break-even proposition at best. But you cannot dip to the negative side and show a loss.

Many small business owners–particularly in this economic climate—are trying to shift their hobby into a bona fide business venture. And if it really is a business venture, then you are allowed to write off expenses in excess of sales and enjoy a loss against other income on your tax return thus reducing your tax liability. The trouble is, you’ve got to prove it.

However, just because you are showing losses in a career that’s more fun than work, does not mean that your business is a hobby. The IRS must prove lack of business intent or have proof that the activity is not being treated as a business.

Prior to the audit, the examiner will look at your tax return.

During the first phase of the audit, the examiner will pose various questions, and your answers could hint at a hobby rather than a business venture. Agents will want to speak to the taxpayer directly, but you have the right to representation and are not required to be present or answer any direct questions from an auditor.

An agent will also perform a “Tax Savings Benefit Analysis,” in which the reported income tax liability will be compared to what the liability would be without the business losses, and then check to see if the business appears to be on a trend toward profitability.

The IRS Audit Techniques manual lists nine factors the auditor will invoke to make the determination of “Whether or not an activity is presumed to be operated for profit requires an analysis of the facts and circumstances of each case. Deciding whether a taxpayer operates an activity with an actual and honest profit motive typically involves applying the nine non-exclusive factors contained in Treas. Reg. § 1.183-2(b) …

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