iS YOuR BuSinESS A HOBBY ? dO nOT LET THE iRS dECidE
Tax law Section Chairs : Brian Harris - Akerman LLP & Christopher Dingman - Barnett , Bolt , Kirkwood , Long & Koche , P . A .
Each year , many “ snowbirds ” pack up their lives and take their talents to Florida . While in Florida , many of these taxpayers decide to pursue a more entrepreneurial endeavor ( in stark contrast to their steady paycheck back home ). That accountant in Philadelphia may make a phenomenal snow cone , and the data processer in Chicago may have always dreamed of selling his one-of-a-kind Polish sausage recipe to the masses . Why not turn these pursuits into full-time businesses ?
While any taxpayer is welcome to use their hard-earned money to start a new venture , not all businesses are treated equally from a tax perspective . Ordinarily , the IRS allows a deduction for all ordinary and necessary expenses paid or incurred by a taxpayer in carrying on a trade or business , and to the extent these expenses exceed the income in a given year , the resulting loss can be used to offset other sources of income in current , previous , or future years . Despite this general rule , deductions related to activities that do not have a profit motive ( in the eyes of the Internal Revenue Service ) are limited to income from that activity .
Whether an activity has a profit motive depends on whether the facts and circumstances indicate that
© Can Stock Photo / EMarket the taxpayer entered into or continued the activity with the intent to make a profit . In examining a taxpayer ’ s intent , the IRS looks to “ objective standards , taking into account all the facts and circumstances of each case ” to determine whether the taxpayer engaged in the activity with a profit motive . To avoid a “ hobby ” classification , the facts and circumstances must indicate that the owner entered into the activity or continued the activity with the objective of making a profit ; however , a reasonable expectation of profit is not required .
To aid in determining whether a profit motive is present , regulations promulgated by the IRS identify nine objective factors ( none individually determinative ) to aid in supporting that an activity is engaged in for profit : ( 1 ) the extent to which the taxpayer carries on the activity in a businesslike manner ; ( 2 ) the taxpayer ’ s expertise or reliance on the advice of experts ; ( 3 ) the time and effort the taxpayer expends in carrying on the activity ;
whether an activity has a profit motive depends upon whether the facts and circumstances indicate that the taxpayer entered into or continued the activity with the intent to make a profit .
( 4 ) the expectation that the assets used in the activity may appreciate in value ; ( 5 ) the taxpayer ’ s history of income or loss from the activity ; ( 7 ) the amount of occasional profits , if any ; ( 8 ) the taxpayer ’ s financial status ; and ( 9 ) the elements of personal pleasure or recreation . Of course , the best way to avoid a fact-intensive discussion ( and to create a presumption that profit motive exists ) is to produce a taxable profit from the activity for two or more taxable years in a period of five consecutive years . Many businesses go through growing pains in their early years . Therefore , to avoid the potential loss disallowances , any new owner should consider the factors listed above ( regardless of the individual ’ s lofty expectations for future profitability ).
Author : Matthew E . Livesay - Barnett , Bolt , Kirkwood , Long & Koche
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