We should all be so lucky as to work in a field that we love. Yet sometimes this can become a gray area in the eyes of the IRS. In order to claim actual business deductions on your tax return, you don’t want there to be any question about whether the activity is a hobby. You’ll need to fit into the IRS description of what running a business actually means.
Tracking Expenses Against Your Business Income
From a financial standpoint, being a small business owner isn’t just about earning money. You’re also able to get tax benefits by reducing the income you’re reporting on your return. Qualified business expenses can ultimately act as their own deductions. That being said, you’ll need to be conducting business-related activity—not just enjoying a hobby that has occasional profits and losses.
One of the first steps in being able to prove that you’re truly in “business mode” is to clearly track your cash flow throughout the year. Obviously you’ll want to keep your expenses organized throughout the year. Beyond that, though, you’ll also need to show that you intend to make a profit. After all, that’s the primary goal of any business!
Showing a loss year after year can start to look suspicious in the eyes of the IRS. You may be consistently investing money for good reasons into the business, and so it’s important to always save the records that can back up those expenses. For example, if you’ve been actively running advertising campaigns to spur on new business, save copies of those materials. Maintain a log of any business meetings that you’ve had on the calendar, and then continue to add to your list of prospective and current customers and clients too.
How the IRS Defines a Business vs a Hobby
Even if you’ve been gaining profits and not just collecting expenses, the activity you’re engaging in still may not be deemed as a business by the IRS. This can become a huge letdown during tax time because if the IRS were to reclassify your business as a hobby you won’t be able to get those deductions. Referencing this quick checklist can help you confirm that you’ll be reporting the activity correctly:
· Do you have experience and expertise in the activity?
· Is the recreational / enjoyment level reasonable?
· Can you show a history of income / profits?
· Are you working in a professional, business-like manner?
· Have you created a business entity?
You should be able to answer “yes’ to the majority of questions listed above. Otherwise, you could be facing some extra scrutiny from the IRS. It’s crucial that you’ll be all set to defend your position that you’re running a business and not just engaging in a hobby. But if you’re still unsure, just call our office!
Let’s Keep Building on Your Success
NSO and Company is an accounting firm based in the Fishers/Geist area near Indianapolis. Our team serves clients throughout all of central Indiana and the surrounding communities, and we specialize in small to mid-size closely held businesses, as well as self-employed taxpayers.
If you’re looking to claim business expenses on your tax return, we can help! Together, we can make sure you’re on-track to prove your business activity and deductions are accurate. And if your activity is technically still classified as a “hobby,” we’d be happy to chat with you about how to take things to the next level!
