Is it Better to Be Taxed as a Hobby or a Business?
Content provided for general information. Talk to your advisor to learn about recent updates or other rules that may apply to your situation.
When you have an activity that is both fun and brings in money, you need to figure out whether you’re a hobby or a business. Often, you need to figure out what tax rules to follow. Other times, you can choose what’s best for you. Here’s how to figure out when it’s better to be taxes as a hobby or a business.
What rules determine whether you’re a business or a hobby?
To determine whether you’re a business or a hobby, you start with the hobby loss rule. If you make a profit in three out of five years, you’re presumed to be a business. If you take a loss in three out of five years, you’re presumed to be a hobby.
Presumed means just that — presumed. The IRS makes a final decision based on the following factors.
- Whether the activity is carried out in a businesslike manner and the taxpayer maintains complete and accurate books and records.
- Whether the taxpayer’s time and effort put into the activity show they intend to make it profitable.
- Whether they depend on income from the activity for their livelihood.
- Whether any losses are due to circumstances beyond the taxpayer’s control or are normal for the startup phase of their type of business.
- Whether they change methods of operation to improve profitability.
- Whether the taxpayer and their advisors have the knowledge needed to carry out the activity as a successful business.
- Whether the taxpayer successfully made a profit in similar activities in the past.
- Whether the activity makes a profit in some years and how much profit it makes.
- Whether the taxpayers can expect to make a future profit from the appreciation of the assets used in the activity.
When can an activity be either a business or a hobby?
Many activities can be either a business or a hobby. For example, there are professional golfers and amateurs that play for fun on weekends.