Thursday, September 27, 2007

Are you running a small business or enjoying a hobby? Part I

So you have started selling your crafts online. You think this might be a hobby or just something to do for fun. Could you actually be running a small business according to IRS rules? Do you have to pay income taxes on your business or hobby?

You have started your small business online and have incurred costs in running your business. You have had few sales and you expect to have a loss. Do you get to deduct the loss on your income taxes?

Well, according to the IRS rules it depends. You need to consider whether you are engaged in a business or just pursuing your hobby. According to the IRS there are some factors you should consider:

  • Do you run the activity in a businesslike manner? For example, do you have records, a business card, a website?

  • Does the time and effort you put into the activity indicate an intention to make a profit?

  • Do you depend on income from the activity?

  • If there are losses, are they due to circumstances beyond your control or did they occur in the start-up phase of the business?

  • Have you changed methods of operation to improve profitability? In other words, are you trying to find ways to make more money through the sales of your crafts.

  • Do you or your advisors have the knowledge needed to carry on the activity as a successful business? Do you have knowledge in selling crafts? Are you consulting others who do?

  • Have you made a profit in similar activities in the past?

  • Does the activity make a profit in some years?

According to IRS rules, an activity is usually considered a business if it makes a profit (profit = sales are greater than costs and expenses) during at least three of the last five years. So, basically whether you are running a small business or enjoying a hobby depends on your intent and whether your activity makes a profit during at least three of the last five years.

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