Business or Hobby?

In order to be treated as running a business for IRS purposes, and to be able to deduct your business expenses, set up a retirement plan, and claim other tax breaks allowed to business owners, you must be engaged in a "trade or business." A profit motive must be present (though you may in fact have experienced a loss) and some type of economic activity must be conducted. This profit motive separates a business from a hobby, which is an activity engaged in purely for self-satisfaction.

"Profit" for purposes of the business activity rules means real economic profit, independent of any tax savings.

• You may qualify for a presumption that you had a profit motive.
• Or, you can establish the profit motive of your business under the nine factors used by the IRS.
• Hobby loss rules kick in if you are unable to prove that you're engaged in a business activity under either of these two methods.

To be deductible, business expenses must be incurred in carrying on an existing trade or business. Costs associated with starting up a business, which are incurred before the business begins to operate, are considered capital expenditures, which are not fully deductible as current expenses.