Taxes Hobby Loss Rules: How to Tell If Your Work Product Is An Occupation Or A Hobby
First, let’s define your occupation. The IRS will apply “hobby-loss” rules according to how serious you are in your profession. If your work is merely a hobby or an occasional income-producing venture, then you can deduct your expenses only to the extent of your income. In other words, you can’t take any losses against other income. Intent becomes a key factor in determining your status. Are you working full-time? Are you earning your entire income from this source? Or do you have a 9-to-5 job and write an article here and there for extra income? The IRS leaves it up to each individual to make an honest determination of whether his or her activities are a hobby or a business. But the IRS gets a big scowl on its face when it sees five or more years of losses from business activity. It’s inclined to audit and disallow the losses if it feels an individual is attempting to write off a hobby. That could be rather expensive because the IRS will go back three years and recalculate your tax liability-including interest-without the losses. In some cases, it may add penalties. Here are some ways to prove business intent so you may enjoy losses against other income:
• Keep business records, either on an accounting software program or on spreadsheets.
• Maintain a separate checking account for transactions related to writing. (This not only proves business intent but will make it easier to track income and expenses.)
• Attend classes and conferences to improve your skills.
• Advertise, network, seek new clients and keep a journal of these activities.
• If you plan to deduct vehicle expenses, keep a mileage log.
• Keep a phone log of business-related calls.
• Obtain any required licenses and insurance.
• Give your business a name.
• Chart future projections and plans to turn the activity into a profitable enterprise. By following the above guidelines, you’ll demonstrate a profit motive and be more likely to convince an auditor you’re serious about your life’s work.
Being organized is one way to prove that your work is something more than a hobby- and it makes filing easier, too. The best thing to do is track your income and expenses on a software program such as Quicken, QuickBooks or Excel. If you take the above suggestion to open a separate bank account, keep careful records of your statements, as well. In making the distinction between a hobby or business activity, take into account all facts and circumstances with respect to the activity. No one factor alone is decisive. You must generally consider these factors to establish that an activity is a business engaged in making a profit:
1. Whether you carry on the activity in a businesslike manner - use proper record keeping.
2. Whether the time and effort you put into the activity indicate you intend to make it profitable - work at building a business.
3. Whether you depend on income from the activity for your livelihood, are you in it for the long haul?
4. Whether your losses are due to circumstances beyond your control, is this the startup phase where losses are acceptable?
5. Whether you change your methods of operation in an attempt to improve profitability, how long can you sustain losses and continue in business?
6. Whether you or your advisors have the knowledge needed to carry on the activity as a successful business - ask questions.
7. Whether you were successful in making a profit in similar activities in the past – you did it before -demonstrate past successes.
8. Whether the activity makes a profit in some years and how much profit it makes - three out of five years.
9. Whether you can expect to make a future profit from the appreciation of the assets used in the activity - purchasing appreciated property like artwork.
I wish I could say this was my own idea, but the truth of the matter, it was the guy who does my taxes. Because of all my writing work and the good that comes of it sometimes (through publishing, productions, etc.), I'm able to deduct some (not all) of my expenses off my tax returns. To make the record keeping easy at the end of the year, I keep a very low-interest, dedicated credit card that I use anytime an expense has something to do with my writing. Nothing else goes on this card—only my writing expenses. At the end of the year, I get a summary and it couldn't be easier to itemize those expenses.”
– Gary Garrison
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