The following court case is a reminder for us all to look at the activities of our business and ask ourselves – is it really business or could it be considered a hobby?
Film Festival Activity Was a Hobby: The taxpayer was the sole member of an LLC that organized film festivals at colleges and universities. He didn’t create a formal business plan, prepare profit projections, or undertake a market analysis for the business. On Schedule C of his income tax return, the taxpayer reported a net loss of over $32,000 attributable to the film festivals. The IRS disallowed the loss, arguing that the activity lacked a profit motive and was therefore a hobby. The Tax Court agreed, holding that the taxpayer didn’t conduct the film festival activity in a businesslike manner and lacked the requisite profit objective. Eric Zudak, TC Summ. Op. 2017-41 (Tax Ct.).
Generally, all activities engaged in that earn income must be reported on your tax return per IRS Code Sec. 61(a) that states “gross income means income from whatever source derived…unless there is a specific exclusion” (IRC Sec. 61(a) Gross Income Defined).
Hobby Activity: Hobby income is not an exclusion of income. Thus, hobby income is reported on Line 21 Other Income on page 1 of your 1040 tax return. Hobby expenses are allowable deductions on Schedule A (subject to 2% AGI limitation) not to exceed the hobby income reported on Line 21. Therefore, you cannot have a net loss from a hobby activity. Hobby income is not subject to self-employment tax.
Business Activity: Generally, when there is an intent to earn a profit, the activity is considered business in which all ordinary and necessary expenses can be used to offset income. Sole Proprietors are deemed to be a disregarded entity, therefore income and expenses are reported on Schedule C of your tax return. Business income is subject to self-employment tax.
When determining hobby vs. business activity, the IRS looks at each case separately. To help, the IRS has nine factors you can use to determine whether you have a hobby or business activity. While these nine factors should be considered, other factors may also need to be considered. No single factor is determinative, and the final decision does not depend on the number of factors indicating a “for profit” activity versus the number indicating a “not for profit activity.” For a checklist of the nine factors to consider and additional information, email us at firstname.lastname@example.org.