The IRS is looking at YOU if you operate a small business that can be
considered a hobby. Typically, those who operate a for-profit business
are allowed to directly deduct from the business income, expenses that
are necessary as well as ordinarily incurred in the operation of that
business. If the business shows an operating loss, then these losses can
be used to offset other income, including wages, interest and dividends.
However, if the IRS rules that the loss is a result of a hobby business,
then the expenses can not be used as a direct reduction to income but,
instead, must be used as an itemized deduction, subject to the 2%
miscellaneous expense rules.
How do you determine if the business activity is a hobby or a viable
business venture is a challenge. Basically, you must be working toward
profitability. If you show an operating profit for three or more years,
you just might be operating a small business. If, however, your
“basement†or “garage†business is just extra cash for side work, you
must report this activity as a hobby and follow all the rules associated
with hobby income and deductions.
Which are you? Answer some of these simple questions:
1. Do you keep thorough and business like books?
2. Are you maintaining a separate business checking and credit card
accounts?
3. Are you carrying the correct business insurance as well as licenses?
4. Do you have a written and updated business plan?
5. Did you create an LLC and have an operating agreement?
6. Do you have professional advisers such as an Attorney and an Accountant?
7. Are you maintaining a “log†of your activity?
In other words, are you REALLY running a small business or do you just
have a “Hobby�
