The IRS reminds would be taxpayers to follow the correct guidelines when determining whether an activity is a home business or a hobby, an activity not engaged in for profit.
In order to educate taxpayers regarding their filing obligations, this guideline explains the rules for determining if an activity qualifies as a business and what limitations apply if the activity is not a business. Incorrect deduction of hobby expenses account for a portion of the overstated adjustments, deductions, exemptions and credits that add up to $30 billion per year in unpaid taxes, according to IRS estimates.

In general, taxpayers may deduct ordinary and necessary expenses for conducting a trade or business. An ordinary expense is an expense that is common and accepted in the taxpayer’s trade or homebased business. Generally, an activity qualifies as a home business if it is carried on with the reasonable expectation of earning a profit. Does this apply to your home based business?

oDoes the time and effort put into the activity indicate an intention to make a profit?

oDoes the taxpayer depend on income from the activity?

oHas the taxpayer changed methods of operation to improve profitability?

oDoes the taxpayer or his/her advisors have the knowledge needed to carry on the activity as a successful business?

oHas the taxpayer made a profit in similar activities in the past?

oDoes the activity make a profit in some years?

oCan the taxpayer expect to make a profit in the future from the expectation of assets used in the activity?

If an activity is not for profit, losses from that activity may not be used to offset other income. An activity produces a loss when related expenses exceed income. The limit on not-for-profit losses applies to individuals, partnerships, estates, trusts, and S corporations. Deductions for hobby activities are claimed as itemized deductions on Schedule A (Form 1040).

Deductions that a taxpayer may take for personal as well as business activities, such as home mortgage interest and taxes, may be taken in full.

Deductions that don’t result in an adjustment to basis, such as advertising, insurance premiums and wages, may be taken next, to the extent gross income for the activity is more than the deductions from the first category. Homebased business deductions that minimize the basis of property, such as depreciation and amortization, are taken last, but only to the extent gross income for the activity is more than the deductions taken in the first two groupings.

Marg Roukens

202-657-5874

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Tri Power Team