There are certain questions you need to ask yourself when it comes to your business. It may be your heart and soul, but will the IRS consider it a real business, or just a hobby? The difference between the two isn’t merely a label, but they both are affected differently by taxes. If the IRS considers you a business, then you fall into a type of business, whether it be LLC or corporation, and there are different tax implications for each.
It all boils down to how you handle your expenses and your losses. A business’s expenses and losses are fully deductible, whereas a hobby’s expenses are deductible only up to the amount of income earned from said hobby. Those with hobbies that generate income tend to label themselves as small businesses because the IRS labels hobbies as “for sport or recreation, not to make a profit.” That makes things a bit more confusing. The difference between a business and a hobby is all about intent, whether it be to improve or grow the business, generate profit, or to just be more successful in said activity. Look for the intent in each of the questions.
How did you carry out the activity?
Did you keep timely and accurate records of your transactions and refer to them to improve as business?
Is this your expertise?
Are you getting professional help to improve your business, whether it be from a mentor, an advisor, or a partner?
How much time and effort are you investing in this activity?
Is it your 9 to 5, or something you do on the weekends to pass time?
Do you expect any assets used to appreciate in value?
Are you expecting to make a profit on assets used that gain value overtime?
Are you successful at carrying out other activities?
Have you gone from unprofitable to profitable in other activities in your life?
What’s your history of profit and loss like when it comes to the activity?
Do you have more history being profitable or unprofitable?
How much is your profit?
The number of occasions doesn’t matter so much as the amount.
What’s your financial status?
Do you have other sources of income, or is this it?
Do you get personal joy or recreation out of this?
Strong personal elements are considered to be a hobby.
If you claim to be a business, you should have evidence to prove so. If you’re a hobby that makes money, the good news is that you won’t have to pay taxes on your income. The bad news is that only some of your expenses are deductible, and the IRS has pretty strict guidelines on this. If you’re unsure, don’t be afraid to do some research on your own!