Is Your Business a Hobby? pt. 6
G.) The amount of occasional profits, if any, which are earned
This falls into the previous categories where the question was about the success of the business. Are you making money in this business? There is a 3-out-of-5 rule where the cannot be losses for more than 3 years in any given timeframe. An additional qualification might be–do your gains in the non-loss years exceed the losses in the years you have a loss? There are a couple of tax court cases out there that cover this. I’ve seen a case where the court ruled that the taxpayer did not have a business simply because, while they had gained $15,000 between the two gain years, it did not exceed the losses in the three loss years which totaled $40,000. The ruling stated that the business was a hobby because the profit would never allow for the business to break even over the five years.
H.) The financial status of the taxpayer
This is a tricky one. They want to know if this is just a rich person’s hobby. If you get into breeding prize poodles and you just keep losing money at it (by giving the puppies away to friends or selling them inexpensively) seemingly have losses to offset your income, the IRS will take that into consideration. It’s basically asking “why are you doing this? Is there a loss motive to your ‘business instead of a profit motive?’” Believe it or not, much like tax shelters, some folks invest into ‘businesses’ in order to have a loss.