Is your business a hobby, or is it a real honest-to-goodness business? That is the question we all must answer at some point before taking the insane leap into entrepreneurship.
Sometimes, knowing whether you’re a hobbyist or business owner is clear. It was for me when I quit my engineering job and started my first “real” business. But other times, it can be hard to tell.
But, fear not, fellow entrepreneurs (err, or hobbyists?). I’m here to help explain IRS business versus hobby rules so you can make an accurate call on what exactly is going on with your startup idea.
Hobby vs. Business
Let me start by saying what you’re all thinking. Who cares if you have a hobby or a business? And let me proceed by saying what the IRS is screaming—We care!
It all boils down to . The IRS needs you to know whether you have a hobby or business so that you can correctly report your income when you file your tax returns. Not to mention, there are some deductions available to businesses that hobbyists (sorry) simply can’t claim.
So, knowing the difference between a hobby vs. a business is pretty darn important.
What’s a Hobby?
A hobby is something that people engage in for sport or recreation. If you have a hobby, your intent isn’t to make a profit. Examples of hobbies may include:
- Swimming
- Hiking
- Biking
- Gardening
What’s a Business?
A business is something that operates to make a profit. Maybe your business grew from a hobby, but its intent now is to make you money. Examples of businesses may include:
- Swim center
- Hiking equipment store
- Bike shop
- Lawn and garden services
Deciding If You Have a Business or Hobby
Photo by Ali Mkumbwa on Unsplash
Sure, it’s pretty easy to tell the difference between a business and a hobby in the above examples. But it’s not always like that. Knowing whether you have a hobby or business can be tricky. To help, the IRS advises that you consider nine things. Determine whether:
- You carry out the activity in a businesslike manner and maintain complete and accurate books and records.
- The time and effort you put into your activity shows you’re trying to make it profitable.
- You depend on the income.
- Losses are beyond your control or are normal for the startup phase of your type of business.
- You change methods of operation to improve profitability.
- You and your advisors (e.g., accountant) have the knowledge needed to carry out the activity as a successful business.
- You were successful in making a profit in similar activities in the past.
- The activity makes a profit in some years (and if so, how much?).
- You can expect to make a future profit from asset appreciation (for assets you use in the activity).
Consider reaching out to a small business accountant or lawyer to help you make a determination about whether you have a hobby or a business.
More articles from AllBusiness.com:
- Marketing Insanity: Doing the Same Old Thing, Expecting Different Results
- How to Turn Your Hobby and Passion Into a Profitable Business
- The Five Risks Even Risk-Averse Entrepreneurs Must Take
- The Coronavirus Crisis Is Revealing These 5 Problems With Your Business Model—Here’s How to Fix Them
- 7 Unnecessary Expenses That New Businesses Should Avoid Until They’re Profitable
But I’m a Real Business! Tips to Help Prove It
Ready to go all in on your startup idea? Ready to chase your dreams and become an official business owner? In some cases, proving you’re a business owner can be difficult, especially if you struggle to make a profit—but, it’s not impossible.
So, first things first. When it comes to making a profit, here’s the scoop. For a business determination, your activity should be profitable for three out of five consecutive years. (Note: There are different rules if you’re in the game of breeding, showing, training, or racing horses.)
But wait, there’s more! You also need to act like a business owner. To do that, you should take action such as:
- Creating a business plan
- Recording accurate accounting books
- Keeping business records to prove your income and expenses
- Complying with federal, state, and local business laws
- Getting the proper business licenses and permits
- Marketing your business
Remember, your business won’t happen overnight (and if it does, kudos to you). Establish best practices to help you gain business status in the eyes of the IRS. And, as always, keep on chasing your dream!
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