Is your income venture a business or hobby?
Posted On: 8-3-2015 | Posted By: Debra Harrington, CPA
Perhaps you own some acreage or a few horses. Do you know how to treat the related income and expenses?
Regardless if you treat the activity as a business or a hobby you enjoy, the income earned is considered taxable income. Expenses related to the activity are deductible in both cases, but the tax outcome can vary significantly. If it is a hobby, the expenses that are ordinary and necessary are considered miscellaneous itemized deductions and cannot exceed income. If it is a business, all income and expenses are reported on Schedule C of your 1040 and expenses are not limited to income.
How do you determine if the activity is a business or hobby? The Internal Revenue Service provides nine factors to consider.
- Is the activity conducted as a business? Is there a separate business checking account and are financial records being kept?
- Are you considered an expert in the field, or do you have knowledge in the area and have sought advice from experts?
- How much of your time is spent on the activity?
- Is there an expectation that assets used in a business will appreciate in value? IRC regulations state appreciation may be considered in lieu of profits. This is generally related to land in a farming activity.
- What’s your history of success? A losing activity can be turned around. There may be losses now, but if you were able to convert an activity from unprofitable to profitable in the past, that would be an indication that the current activity is engaged in for a profit.
- What is the history of income or loss with respect to the activity? How long have losses been incurred? The general rule has been if an activity has net income for three of the last five years, it generally is presumed to be for-profit activity. For horses, it is three out of last seven years.
- Does your activity support your profit intent? IRC regulations state, “the amount of profits in relation to the amount of losses incurred, and in relation to the amount of the taxpayer’s investment and the value of the assets used in the activity, may provide useful criteria in determining the taxpayer’s intent.”
- Do you rely on this income? What, if any, other sources of income exist?
- Does the activity include elements of personal pleasure or recreation?
No single factor controls the determination of business or hobby. All factors listed above are considered in relation to the type of activity and the surrounding facts and circumstances.
If you would like additional information or guidance on a current endeavor, or if you are considering starting a business and need assistance in getting started and/or structuring in manner that makes the most sense, please contact your WK advisor at (573) 442-6171 or (573) 635-6196.