When should my hobby become a business? It sounds like a simple question but there isn’t a simple answer, unfortunately. Whether it’s sewing, painting, cooking, or performing – any hobbyist and business owner should understand the IRS’s rules for what qualifies as a business or a hobby. Whether your venture is a hobby or a business affects your tax liability. In addition to the tax implications, you should also consider your legal requirements and protection.
Let’s start with what the IRS has laid out for everyone when it comes to distinguishing a business and a hobby. First, as a general rule, a main element of a business is to turn a profit. Any income earned from a hobby must be reported on your tax return. There isn’t one decisive factor that categorizes your activity as one or the other. In fact, there are nine factors you’ll have to consider to establish an activity as a business. Those factors are listed below:
· Whether you carry on the activity in a businesslike manner.
· Whether the time and effort you put into the activity indicate you intend to make it profitable.
· Whether you depend on income from the activity for your livelihood.
· Whether your losses are due to circumstances beyond your control (or are normal in the startup phase of your type of business).
· Whether you change your methods of operation in an attempt to improve profitability.
· Whether you or your advisors have the knowledge needed to carry on the activity as a successful business.
· Whether you were successful in making a profit in similar activities in the past.
· Whether the activity makes a profit in some years and how much profit it makes.
· Whether you can expect to make a future profit from the appreciation of the assets used in the activity.
As a business, you’re able to deduct business expenses. However, if you deduct expenses when you’re not a real business, you can face some stiff penalties. If the IRS declares your activity as a hobby, you can deduct your hobby expenses up to the amount of income you earn from that hobby.
So, why should you consider forming a business entity? Well, the obvious reason for many people would be the tax deductions. But you have to ask yourself if you can prove that your venture is in fact a business in front of an audit. The other reason is to protect your assets. There are many more ways to protect yourself with a business entity than as an individual. If there is something you really enjoy, and believe you can make a livelihood from, maybe establishing a business isn’t out of the question for you. Make sure to comply with federal, state, and local business laws. Make sure you take every step to make your business legal. Consider hiring legal counsel in Las Vegas before forming your business.