Is Your Hobby a For-Profit Endeavor?

The Internal Revenue Service reminds taxpayers to follow appropriate guidelines when determining whether an activity is engaged in for profit, such as a business or investment activity, or is engaged in as a hobby.

Internal Revenue Code Section 183 (Activities Not Engaged in for Profit) limits deductions that can be claimed when an activity is not engaged in for profit. IRC 183 is sometimes referred to as the “hobby loss rule.”

Taxpayers may need a clearer understanding of what constitutes an activity engaged in for profit and the tax implications of incorrectly treating hobby activities as activities engaged in for profit. This educational fact sheet provides information for determining if an activity qualifies as an activity engaged in for profit and what limitations apply if the activity was not engaged in for profit.

Is your hobby really an activity engaged in for profit?

In general, taxpayers may deduct ordinary and necessary expenses for conducting a trade or business or for the production of income. Trade or business activities and activities engaged in for the production of income are activities engaged in for profit.

The following factors, although not all inclusive, may help you to determine whether your activity is an activity engaged in for profit or a hobby:

Complete IRS Bulletin:
http://www.irs.gov/irs/article/0,,id=186056,00.html

And MY question is this. If, due to circumstances beyond my control, ie surgery last year, bad economy, etc. prevents me from making a profit (after deductions) I can't sell at craft shows in the state of Texas w/o a sales tax ID. So can a hobbyist operate a sales tax collecting business and remain a hobbyist?

"So can a hobbyist operate a sales tax collecting business and remain a hobbyist?"

According to the IRS, yes - you're just complying with local regulations. Your local state would probably agree, but you should check to make sure.

Since Texas has no personal income tax, I doubt they care one way or the other -- they just want their "fair share" from the individual sales.

I guess I'm confused. I assumed that because I have a DBA and sales tax ID, that I HAD to file as a business with the IRS.

"...because I have a DBA and sales tax ID, that I HAD to file as a business with the IRS."

Your sales tax ID and DBA has no direct bearing on the IRS determining whether you have a business or hobby. If you had a Federal Tax ID it would have more, but not definitive bearing.

From another IRS bulletin:
What is a hobby? Hobbies, also called not-for-profit activities, are those activities that are not pursued for profit. What is a business? Generally, your activity is considered a business if it is carried on with the reasonable expectation of earning a profit.

If you are not sure whether you are running a business or simply enjoying a hobby, here are some of the factors you should consider:

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Does the time and effort put into the activity indicate an intention to make a profit?
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Do you depend on income from the activity?
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If there are losses, are they due to circumstances beyond your control or did they occur in he start-up phase of the business?
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Have you changed methods of operation to improve profitability.
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Do you have the knowledge needed to carry on the activity as a successful business?
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Have you made a profit in similar activities in the past?
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Does the activity make a profit in some years?
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Do you expect to make a profit in the future from the appreciation of assets used in the activity?

An activity is presumed carried on for profit if it makes a profit in at least three of the last five tax years, including the current year (or at least two of the last seven years for activities that consist primarily of breeding, showing, training or racing horses).

Ref URL: http://www.irs.gov/newsroom/article/0,,id=172833,00.html

Again, note there is no reference to either name (many successful hobbyists sell under a DBA; i.e., "Quilts By SuzieQ) or collection and payment of sales taxes

Also, keep in mind that the IRS actually prefers for private activity to be classified as a business, not a hobby. Their position is that too many people (and they supposedly have the stats to prove it) use hobby activities to generate looses to offset other taxable income. I've never heard of the IRS challenging a business by asserting they were in fact a hobby; challenges are exclusively against hobbyists generating losses above and beyond the cost of operating their hobby.

So, a very good rule of thumb is if you are declaring your activity a hobby, but consistently showing losses to offset other income, you might brace for an eventual challenge of your status. If you're consistently showing a profit (and you have to report the profit as taxable income either way) you can handle you activity either way -- however, if you are consistently profitable you are probably leaving deductible business expenses off your returns by claiming to be a hobby.

If you need more info for your own activity, either order - or read online -- IRS Publication 535, Business Expenses.

Correct IRS website: http://www.irs.gov

Well, now, this is really interesting! LOL Yes, my intention is make money, but after all the deductions last year, I showed a loss and will probably show a loss again this year because I have done very few shows. I have, however, shown a profit in previous years. I do not depend on it for my livihood, thank goodness, but started it with the intention of supplementing my income especially when I retire. Hmmm!

So glad you brought this up!

"...last year, I showed a loss and will probably show a loss again this year..."

Happens to the best of businesses of all sizes! So long as it's not a continual annual result, and you have declared profits in the past, you shouldn't have any problems.

It usually (but not written in stone) takes the IRS about 5 - 6 years to make the determination to challenge a business about being in actuality a hobby due to continued losses.

I have taken a loss for the past 4-5 years. This year I made it a full time business, so I will show a profit, I'm sure. As for it being OK or not, ask my CPA.