Differences between an active business and a hobby for IRS Purposes

Determining if an individual is engaged in carrying on a trade or business has implications beyond whether a net loss will be allowed to offset other income, although this income offset is the most obvious benefit for many taxpayers.

 

Hobby or Business in View of IRS

The Internal Revenue Code backs into the rules governing activities not engaged in for profit (commonly referred to as hobbies) by including all activities of the taxpayer other than those for which deductions are allowable under IRC Sec. 162 (expenses of carrying on a trade or business) or 212 (expenses incurred for the production or collection of income or for the management, conservation, or maintenance of property held for the production of income)

 

Items affected by hobby or business determination include:

  1. Self-employment (SE) tax and, ultimately, social security benefits.
  2. IRA, Keogh, SEP, or SIMPLE retirement plan contributions.
  3. Deductions for health insurance premiums and contributions to health savings accounts (HSAs).
  4. Home office deductions.
  5. Section 179 Deduction
  6. Amortization of start-up expenditures.
  7. Character of gain or loss upon disposition of assets
  8. Net operating loss (NOL) carryovers and carrybacks.
  9. AGI-sensitive deductions including rental losses, medical expenses, casualty losses, etc.
  10. AGI-sensitive credits.
  11. Deferral of estate tax and the special-use valuation of assets.

 

Taxpayers need to be careful to ensure that their business is not treated as a hobby.