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The business versus hobby distinction

On Behalf of | Sep 20, 2019 | Tax Controversies |

Many people in White Plains and the other communities around New York City have hobbies. In most cases, people probably think of a hobby as something that a person spends money on in order to get a non-financial benefit, like relaxation or personal satisfaction.

There are, however, many hobbies in which a New Yorker can also make a little extra cash. By way of example, someone who likes to sew may do a few projects for others and make some money for their work.

Like all other forms of income, this extra cash is reportable to the IRS and will get included when calculating a person’s federal income tax obligation. The nice thing about hobbies is that, just as a person must include any income they make, they are also able to deduct expenses associated with their hobby. For example, someone who sews a dress and collects $100 can deduct the cost of fabric and supplies.

The catch is that, unlike full-blown business income, or expenses, a taxpayer cannot claim an operating loss on his or her hobby and thus reduce his or her other income.

The reason is that, to the IRS’s thinking, hobbies are not meant to produce income and thus should not be used to claim losses which the taxpayer in all likelihood fully expected.

Whether a business is truly a business or a hobby can lead to tax controversies. Perhaps because it is concerned that unscrupulous taxpayers will use their hobby as a sort of tax shelter, the IRS will ask several questions about a person’s business activities in order to determine whether there really is an intention to make a profit as opposed to engage in a hobby.

Someone whose business activities are getting scrutinized in this respect should strongly consider consulting with an experienced tax attorney.