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  • Writer's pictureKathryn Bruns, CPA

Hobby or Business ?

Are you aware of why it is important to consider whether your activity is deemed a hobby or business in the eyes of the IRS?

If you are truly operating a business, and it has a net loss, then you can deduct the loss for tax purposes and enjoy a lower tax bill. However, if the "business" is really just a hobby, then you cannot deduct losses. As you can imagine, many taxpayers would seek to claim that their "fun" activity is really a business, and not just a hobby. So of course, for the IRS this is a "red flag" area and deciding which it is can be a very subjective and gray area.

Recently, the IRS looked at a fishing charter "business". The taxpayer was an avid fisherman in Alaska. When he retired from his normal day job, he got a boat for halibut fishing. He stored the boat with relatives that lived in another city. He rented a commercial fishing permit for halibut and had 11 fishing trips during 2015 and 2016 with paying customers. He also took the boat out for personal fishing. He did a little promoting of the business, and he did not have a separate bank account for the fishing business.

In addition to this fishing activity, he earned money from social security, pension, and a two property rentals. The fishing activity money was not a necessary part of income that he lived on.

The IRS regulations consider the following nine factors when deciding if a claimed business is actually a hobby:

1)The manner in which the taxpayer carries on the activity,

2)The expertise of the taxpayer or the taxpayer’s advisers,

3)The time and effort expended by the taxpayer in carrying on the activity,

4)The expectation that assets used in the activity may appreciate in value,

5)The success of the taxpayer in carrying on other similar activities,

6)The taxpayer’s history of income or loss with respect to the activity,

7)The amount of occasional profits, if any, which are earned,

8)The financial status of the taxpayer, and

9)Whether elements of personal pleasure or recreation are involved.

Based on all of the facts and the rules, what do you think the IRS concluded? I found this to be a tough one. He did have paying customers and incurred expenses to serve them....but he did have a lot of personal use, as well as not dedicating too much time and effort on making a profit. The IRS concluded that it was a hobby. The taxpayer appealed to Tax Court but did not win. I'd say this could have gone either way, and it is important for you to have a tax advisor who can see both sides of a position and weigh the risks and rewards of taking the aggressive position on a hot topic such as business versus hobby. A simple takeaway is to ensure you have a separate business bank account for any activity you plan to claim as a business and do not commingle it with any personal accounts.

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