Say I build a tennis website in my spare time . It gets popular and I start putting sponsor advertising on it. If I earn $100/month from it, would I consider it a non-profit activity or a business? I understand I owe taxes on the $100/month.
I suppose if I earned enough to live off it then I would consider it a for-profit business. But if the income can not sustain one person's livelihood , then what should it be called? And is there a standard definition of "livelihood" ?
The profit motive (or lack thereof) for an activity is not determined by the dollar amount; rather there are nine factors the IRS considers, no one of which is determinative by itself. In other words, there is no "formula", only facts and circumstances.
The list of the nine factors, plus other relevant info, can be found here:
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8400,00.html#chapter01_05 As has been pointed out here before, this is a two-edged sword for the IRS. A for-profit activity incurs self-employment tax on profits, while a hobby does not typically result in deductible expenses (since they go on Schedule A, subject to 2%-of-AGI limitation). Which one do they want? They can't have it both ways.
I have a revenue-generating hobby that I would *love* for the IRS to classify as a for-profit activity, then I could take a net loss against my other income!
The profit motive (or lack thereof) for an activity is not determined by the dollar amount; rather there are nine factors the IRS considers, no one of which is determinative by itself. In other words, there is no "formula", only facts and circumstances.
The list of the nine factors, plus other relevant info, can be found here:
formatting link
8400,00.html#chapter01_05 As has been pointed out here before, this is a two-edged sword for the IRS. A for-profit activity incurs self-employment tax on profits, while a hobby does not typically result in deductible expenses (since they go on Schedule A, subject to 2%-of-AGI limitation). Which one do they want? They can't have it both ways.
I have a revenue-generating hobby that I would *love* for the IRS to classify as a for-profit activity, then I could take a net loss against my other income!
OP: don't be misled by this statement. Although there are circumstances where $1 in profit will defeat the presumption, there are circumstance where it will not. Refer to Mark Bole's response.
I disagree. Section 183(d) indicates "gross income ... exceeds the deductions....". As long as that happens for the requisite number of years (3 of 5 or 2 of 7, depending on the activity), the presumption statutorily is assumed. Nowhere does Section 183 require that the profit be sufficient to live on -- the ONLY requirement is that there's a net income.
A $1 profit does not defeat the presumption. It may defeat the ultimate determination, but the burden of what needs to be proven does in fact change.
With a loss, the taxpayer needs to show that it is a business (to take the loss). With a profit, the taxpayer needs to show that it is a hobby (to avoid SE tax).
Your clarifications are always better than your original responses. However, how does a single dollar defeat the presumption if you need to show a profit in 3 out of five years? Since we round off the cents, that would be one dollar for a single year, at most, or 33 cents for three years, rounded down to zero. We really don't need to argue this, just refer to Mark Bole's post and the statute.
You're talking only about a presumption, not the rule. The rule is that it must be an activity engaged in for a profit. If you do not intend it to make a profit, even if it does, you're not entitled to a deduction. The presumption affects the burden of proof. If it makes money for three years out of five, it will be presumed to be for profit, "unless the Secretary establishes to the contrary," as the statute says.
Furthermore, the statute only makes a "presumption" under a specific set of circumstances: a profit in three of the last five years, including the current taxable year.
There is no presumption of anything if you don't meet those conditions, including if you haven't yet completed three years of activity (the situation of the OP).
Since there is no reporting requirement of what the "profit" for a hobby would have been when "determined without regard to whether or not such activity is engaged in for profit" (the language of the statute), how is the IRS going to be able to presume anything if you haven't been filing Schedule C?
Suppose I reported hobby income on Form 1040 Line 21 for 2005, 2006, and
2007. Stussy, are you saying that the IRS can go back to 2005 (a statutorily closed year) and force me to prove that, had I reported the activity as a business, it would not have made a profit? Otherwise, they can "presume" that my money-losing yet revenue-generating hobby is truly a business?
Which, of course, is probably exactly the outcome I would prefer. Yet I would still be screwed for the closed years when I could have been taking a loss on Schedule C instead of reporting income on Line 21.
I recall that this topic has been exhaustively discussed here in years past. I was under the impression that this presumption was actually designed to benefit the taxpayer, otherwise why would there be an election available to postpone determination of the presumption? Such an election would be used when claiming a large loss in the first two years, yet anticipating a profit in the subsequent three.
If a hobby yields a profit (easy, because as a hobby very little is deductible), isn't it required to be reported? (OK, even with that reported, if the expenses are under 2% they probably aren't reported, so the "profit if a business" can't be determined.)
Since you haven't under-reported your income by 25% (since you reported it all, just maybe on the wrong form) they don't get 6 years. If they claim you were comitting fraud by intentionally reporting a business as a hobby, they might be able to re-open that year; would such a claim pass the laugh test?
If the IRS gives you more than you should get for several years (the open ones), it seems churlish to complain that they aren't giving you even more.
That's not how I interpret the statute. The presumption is not based on hobby-style reporting, but Schedule C-style reporting.
IOW, my hobby's "profit", determined without regard to whether or not such activity is engaged in for profit, actually yields a real-world, accounting loss. If I put it on a Schedule C, it would be a loss, which is what the presumption is based on. It's only because I can't deduct the expenses for tax purposes that it appears to be a profitable hobby.
Which is why, I suppose, profit motive is ultimately determined not by whether or not you actually made a profit, but instead by the nine factors. The statute provides for a presumption, but it's open to interpretation what the intent of allowing the presumption was, especially since the Secretary can do with it what he will.
It's not "more than I should get" if the activity is actually classified as a for-profit activity, contrary to my original position.
I would only agree that a $1 profit in three of the last five years is sufficient to enable the presumption. There's nothing to defeat if the presumption doesn't exist in the first place.
I think he was referring to the size of the profit, meaning even $1 of profit is still a profit for purposes of the statute.
I agree. The statute says that there is a presumption when the income exceeds the deductions for three out of five years, there's a presumption that the business is engaged in for profit. It does not say there is a presumption that it's not engaged in for profit if the business does not make a profit.
On the other hand not having a presumption means the IRS can place the burden of proof on the business owner, since the courts generally consider the IRS position to be presumptively correct unless proven otherwise. So in practical effect the presumption does change.
If a business earns $1 profit for each of ten consecutive years, it may qualify for the presumption but I think it would be reasonable to conclude that it was not truly engaged in for profit, and the presumption might be rebutted.
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