Mar 01, 2017 07:06 PM EST

Taxes: The Difference Between A Hobby And Business

There are a lot of people who are not well aware if what they are doing is a hobby or a business. It is important that you know the difference between the two. Whether you are just earning a little money on the side or you are going for it full blown.

Business is an activity that is intended for commercial use in order to make a profit. On the other hand, a hobby is an activity that one does during their free time. Most of the time, they do this because they love and enjoy it.

Forbes shared that whether the venture that you are doing is a hobby or a business it still affects your tax liability. The IRS has rules on what to qualify as a business. You cannot declare that what you are doing is a hobby if it actually falls into business. If it is a hobby, then you cannot deduct business losses and expenses on your tax return. You are only allowed to deduct hobby expenses.

According to the IRS, when making the distinction between a business and a hobby, you must take into account all facts and circumstances of the activity you are doing. Here are the factors that you have to consider to identify if that activity is business engaged and making a profit.

First, is your activity done in a businesslike manner? You must also consider the time and effort you put in the activity. Are you doing this in order to make it profitable? Another thing is whether you depend on of the income of the activity for your livelihood.

Aside from that, you must know if the losses are due to uncontrollable circumstances and do you apply changes to improve your profit. And also, do you and your advisors have enough knowledge and experience to carry on the activity as a successful business? Most of all, can you expect to make a future profit from the assets used in the activity?

It is not easy to prove your business intentions. There is no simple method of doing it. But to meet the IRS requirement for a business, you must make a profit.

Liberty Tax Service’s Brian Ashcraft shared that “If you take a loss on a business for more than three years, the IRS considers it a hobby, and it is not eligible for preferential tax treatment. The IRS assumes that if an activity isn’t profitable for at least three of the prior five tax years, including the current year, then losses from that so-called business cannot be used to offset other income,” via Entrepreneur.

Meanwhile, Jobs & Hire shared helpful tips on starting a successful business. It helps a lot that you have a guide as you start your venture.

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