Part 5A: Business or hobby?
Mar 21 '00
This epinion deals only with the question of whether you have (or want to have) a "business" or "hobby", and where to report income and expenses. Part 5B will deal with depreciation and expensing, and part 5C will deal with other deductible expenses.
Business or hobby?
The IRS has 9 factors (quoting from publication 535) which help determine whether your activity is a business or hobby. The factors are whether:
1. You carry on the activity in a business-like manner,
2. The time and effort you put into the activity indicate you intend to make it profitable,
3. You depend on income from the activity for your livelihood,
4. Your losses are due to circumstances beyond your control (or are normal in the start-up phase of your type of business),
5. You change your methods of operation in an attempt to improve profitability,
6. You, or your advisors, have the knowledge needed to carry on the activity as a successful business,
7. You were successful in making a profit in similar activities in the past,
8. The activity makes a profit in some years, and how much profit it makes, and
9. You can expect to make a future profit from the appreciation of the assets used in the activity.
There's a separate 3 of 5 rule; if you make a profit in 3 of 5 years, it gives you a presumption of having a business rather than a hobby, but the IRS can still challenge it.
For example, in the case of your effort on Epinions, factors 1 and 2 are up to you, factor 3 is unlikely, factor 4 is virtually impossible, factor 5 is up to you, factors 6 and 7 are very unlikely, factor 8 is probable that you'll make a profit unless you deduct the cost of items reviewed or your ISP costs, and factor 9 is highly unlikely.
Do you want to have a business?
Bear with me on this. If your net income exceeds $433, and you have few expenses, your taxes will be lower with a hobby than with a business, as you have self-employment taxes if you have a business. I'm not sure how you can structure yourself to have a hobby rather than a business, in those cases. I would suggest emphasizing factors 1, 3, and possibly 2, at the expense of factor 8.
Where to file income and expenses
If you have a non-rental business, use schedule C for both income and expenses. If you have a profit exceeding $433, you will also have to file schedule SE (self-employment income).
If you are renting real property, use schedule E for income and expenses.
If you are renting personal property, then income goes on line 21 (miscellaneous income) and expenses go on line 32 (miscellaneous adjustments).
Finally, if you have a hobby, then income goes on line 21, but expenses (to the limit of the amount of income) are miscellaneous itemized deductions, along with employment-related deductions.
Furthermore, if you have a rental business in which you actively participate (e.g., choosing the renters), you can deduct only $25,000 in losses (the excess is suspended); and if you have a business in which you don't actively participate (many tax shelters come to mind, but also some of the Internet pyramid schemes -- I mean multi-level marketing -- in which your downline is selected for you automatically), losses are suspended until you divest yourself of the business.
Exactly what you can deduct as expenses will be in other Epinions.
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Epinions.com ID:
Arthur.Rubin
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Member: Arthur Rubin
Location: Brea, CA, USA
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About Me:
Expert in mathematics, computers, income tax, with a wide variety of interests.
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