I’m sure most of you have heard “Treat your business like a business and it will pay you like a business. Treat your business like a hobby and it will cost you like a hobby.” or something similar. In order for your home business to be successful, you need to treat it as a business and not a hobby.
However, while this is important in terms of your earning potential, equally important is how the Internal Revenue Service (IRS) views your business. In the U.S., the tax advantages alone can make having a home-based business the single best financial move you could ever make but ONLY when the IRS determines that you are actually running a business engaged in for profit. If they think it’s a hobby and not a business engaged in for profit, your ability to deduct expenses is limited.
Are you treating your business like a business or like a hobby? How do you know?
A good starting point is to ask yourself the following questions and making sure your activities pass the test. These following 9 factors, although not all inclusive, will help you to determine whether your activity is an activity engaged in for profit or a hobby as determined by the IRS:
1. Manner in which the taxpayer carries on the activity (keep books, maintain an office, etc.)
2. The expertise of the taxpayer or his advisors
3. The time and effort expended by the taxpayer in carrying on the activity
4. Expectation that assets used in activity may appreciate in value
5. The success of the taxpayer in carrying on other similar or dissimilar activities
6. The taxpayer’s history of income or losses with respect to the activity
7. The amount of occasional profits, if any, which are earned
8. The financial status of the taxpayer
9. Elements of personal pleasure or recreation
Many home business owners fear that their returns will be audited by the IRS. However, too often the thought is only in terms of deductions so it’s important to understand this additional piece. If selected for audit, the IRS may also be making a factual determination whether your activity is engaged in for profit. Therefore, it is to your advantage to be proactive by ensuring that your activity supports and demonstrates that it is, indeed, a trade or business engaged in for profit. Otherwise, your deductions could be disallowed so this is a great place to start.
*Disclaimer: This article is meant for informational and discussion purposes ONLY. It is not intended in any way to be construed as tax advice. For expert advice, seek out the appropriate professional who can represent your interests.
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To Your Success!