Hobby Vs. Profession And The Expectation Of Profit

When the Internal Revenue Service assesses tax on your business income

, it permits the deduction of the ordinary expenses that are necessary to earn that income. When the expenses sometimes exceed the revenue, the loss is deductible against other sources of income. But the activity incurring the expenses must have the expectation of profit. That is, the IRS will deny deductions that are related to non-business hobbies. Distinguishing between a business activity and a hobby is an area of the expertise attained by a tax enrolled agent.

However, you do owe tax when your hobby produces income. In that case, you can deduct hobby expenses from the income produced. However, the deductible expenses cannot exceed the income received. One aspect of enrolled agent ethics is helping taxpayers avoid incorrectly deducting hobby losses. The purpose of an enrolled agent ethics course is providing training to avoid situations where income is under reported.

In addition, only taxpayers who itemize deductions can deduct hobby expenses up to the amount of income the activity produces. Even then, the deduction is limited to the amount by which the expenses exceed 2 percent of adjusted gross income. If the hobby regularly produces income, you will benefit by trying to make it a regular business. To achieve this, you need to always try making enough revenue to exceed your costs.

A regular business will incur taxable profits but at least the deduction of your expenses is not limited. In that situation, you can also deduct business losses in the years that you don't make a profit. You can also likely include more deductions than were possible for hobby expenses. For example, by following certain rules, a self-employed proprietor is entitled to a home office tax deduction.

You only need to demonstrate to the IRS that your activity is a legitimate business endeavor. Enrolled agent hours are devoted to studying the right procedures for achieving such objectives. Two tests are deployed by the IRS to assess if your activity is a hobby instead of a business. The first test involves demonstrating that an activity has a taxable profit in three out of every five years. If you can't pass that requirement, the next step is the factors-and-circumstances test. Although admittedly subjective, the IRS considers the total impact of the following factors:

How much time and effort you devote to the activity.

Your conduct in carrying on the activity, such as keeping businesslike records.

If start-up losses are normal for the particular type of business.

Whether you depend on income from the activity for your livelihood.

If you make efforts to improve profit from the activity.

Whether you possess knowledge about the specific type of business.

Your past business experience.

Whether you expect profits, how often, when, and how much.

You may benefit from assistance of an enrolled agent if you have to convince the IRS of your good-faith attempt to operate a profitable business. Completion of enrolled agent CPE prepares these professionals to represent you before the IRS.

by: Sawyer Adams

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