⚡ Get All Content for 20% Off ⚡

Do You Have a Business or Just a Hobby? When it comes to taxes, knowing the difference could mean the difference between complying with the law--or breaking it.

By Cliff Ennico

entrepreneur daily

Opinions expressed by Entrepreneur contributors are their own.

If you're making money at whatever you do, the IRS reallydoesn't care if it's a hobby or a business. They want theirmoney. "Gross income," as the IRS defines it, includesincome "from whatever source derived." So let's sayyou're a coin collector. You sold two coins on eBay last yearjust to get them out of your collection, and you made $100 profitdoing so. You should report the $100 as income on your tax returnthis year.

The "business vs. hobby" distinction truly comes intoplay when you lose money. So, in my example above, if youlost $100 when you sold the two coins on eBay, the IRS wouldn'tlet you deduct the $100 against your income from other sources,such as your day job. You can only deduct "hobby losses"against gains from the same hobby. So if this year you sell fivecoins on eBay, making a $200 profit on two of the coins and a $200loss on the other three, you can "net" the loss againstthe profit and report zero income from your hobby.

A professional coin dealer doesn't have to worry about thisbecause he or she is clearly engaged in a business. How do you tellthe difference, especially when the business involves buying andselling stuff, something that many people do as a hobby--such asselling coins or antiques on eBay; breeding cats, dogs or otheranimals; making arts and crafts for sale at craft shows; publishinga newsletter; participating in various kinds of home party saleswhere your main objective is to get discounts on the products; andother activities where your primary objective is personalsatisfaction rather than economic gain.

Under a long-standing IRS rule, you're considered a"business" if you made a profit in three of the past fiveyears, including the current year. But what if you are juststarting out and are likely to lose money this year?

Don't lose hope. You may still be considered a"business" for tax purposes if you can prove to the IRSthat you're taking your activities seriously and are treatingthem as a business with the primary goal of making a profit . . .eventually.

So what sorts of things do you need to do? At a minimum, youshould have a name for your business, some stationery, invoices, aseparate bank account, separate books and records, a place in yourhome that's used only for this business activity, and somerecords to show that you're spending some time working on thisactivity on a regular basis. For example, if you're a coincollector turned coin dealer, you should keep thorough accounts andrecords, advertise in hobby publications, attend coin showsregularly in your area, and consider forming a corporation orlimited liability company to run the business.

You should also consider preparing a formal business planshowing your projected income and expenses over a five- or ten-yearperiod--with some profit at the end of that period. It would alsohelp if you could show that you're actively studying andlearning how to be financially successful in your business.Attending seminars, subscribing to trade magazines or newsletters,buying (and reading) books about the business and consulting withvarious professionals will also help.

Oh, and try not to look as if you're having too much fun. Ifthe IRS audits your business, and the walls of your home office arecovered with rock concert posters, you're toast. Unless, ofcourse, you're dealing in vintage rock posters.


Cliff Ennico is a syndicated columnist, author and host ofthe PBS television series MoneyHunt. This column is nosubstitute for legal, tax or financial advice, which can befurnished only by a qualified professional licensed in your state.Copyright 2005 Clifford R. Ennico. Distributed by Creators SyndicateInc.

Cliff Ennico is a syndicated columnist and author of several books on small business, including Small Business Survival Guide and The eBay Business Answer Book. This column is no substitute for legal, tax or financial advice, which can be furnished only by a qualified professional licensed in your state.

Want to be an Entrepreneur Leadership Network contributor? Apply now to join.

Side Hustle

The Remote Side Hustle a 43-Year-Old Musician Works on for 1 Hour a Day Earns Nearly $3,000 a Month: 'All From the Comfort of Home'

Sam Ziegler wanted to supplement his income as a professional drummer — then his tech skills and desire to help people came together.

Leadership

Former Interrogator Shares 5 Behaviors Liars Exhibit and How to Handle Them

Five deceptive behaviors to look for and how to respond to those behaviors when you encounter them.

Business News

AI Is Impacting Jobs. Here Are the Gigs Affected the Most, According to an Analysis of 5 Million Upwork Postings

The researcher said in the report that freelance jobs were analyzed first because that market will likely see AI's immediate impact.

Business News

Tesla Paid No Federal Income Taxes Over 5 Years, While Paying Top Execs $2.5 Billion, According to a New Report

Between 2018 and 2022, more than 30 companies paid its top five executives more than they paid in federal income taxes.

Money & Finance

How Stock Market Fluctuations Really Impact Your Business (and How to Thrive Amidst Volatility)

The impact of stock market fluctuations is complex and far-reaching. It doesn't just affect individual investors; its ripple effect impacts businesses everywhere. Here's how.