DOWN TO BUSINESS
A look at small business questions from the Southwestern Oregon Community College Small Business Development Center (SBDC).
By Arlene M. Soto CMA, CGBP, Southwestern SBDC Director
If my business is not profitable, will the IRS consider it a hobby or a business?
The Internal Revenue Service (IRS) looks at unprofitable businesses with a suspicious eye. The laws and regulations, however, do not provide a specific definition of what constitutes a trade or business because no single definition can apply to all cases. Generally, a trade or business must be an activity that is carried on with a profit motive, the owner is usually actively involved and some economic activity must be conducted. The problem is that the "burden-of-proof" is on the business owner.
There are several key factors the IRS considers in determining whether activities are engaged in for a profit. Some of those criteria are: activities must be done in a business-like manner similar to other activities of the same nature that operate profitably; the expertise of the business owner in the industry; time and effort the business owner puts toward the operation of the business; relying on profits from the business for personal living expenses is also an indicator; start up losses may be present and do not control distinction, but continued losses without any attempts to improve or correct the business might indicate you are not engaged in it for a profit. The IRS considers any business operating at a loss for more than three years suspect.
There must be a good faith objective and expectation of making a profit to have the activity considered a business. If your business is struggling—seek advice, consider its effect on your business's profitability and if you think it will make your business more profitable, why not implement the changes. It will help support your argument that you are in BUSINESS and it is not a HOBBY.
If you are in doubt whether your activity is a business or a hobby visit the IRS website at www.irs.gov and find fact sheet FS-2007-18 entitled “Business or Hobby? Answer Has Implications for Deductions” or contact your accounting professional.