Business vs. Hobby; Which Does Your Business Qualify As?


The "activity for profit test" is a concept primarily used in tax law, particularly in the U.S., to determine whether an activity is engaged in with the intent to make a profit—which affects whether the taxpayer can deduct related expenses.


This test is most often applied by the IRS  when deciding if an activity is a business or a hobby  under Internal Revenue Code (IRC) Section 183, known as the “hobby loss rule.”


Purpose:


To determine whether the taxpayer's activity qualifies as a business (allowing deductions for losses) or a hobby (where deductions are limited).


Key Factors (from IRS regulations)


There is no single test, but the IRS looks at 9 factors to evaluate whether an activity is carried on for profit:


Manner in which the taxpayer carries on the activity

  • Is it run in a businesslike manner with complete and accurate records?


Expertise of the taxpayer or their advisors

  • Has the taxpayer studied the business or consulted experts?


Time and effort expended on the activity

  • Significant time investment suggests a profit motive.


Expectation that assets used in activity may appreciate

  • Profit may come from asset appreciation, not just operations


Success in carrying on other similar or dissimilar activities

  • Past success in similar ventures supports profit motive.


History of income or losses

  • Consistent losses may suggest your business is a hobby, though not always.


Amount of occasional profits, if any

  • Substantial profits, even infrequent, may suggest a business.


Financial status of the taxpayer

  • If the taxpayer has other income, this may indicate the activity is not essential for  profit.


Elements of personal pleasure or recreation

  • If the activity is also enjoyable or recreational, it may be a hobby.


Presumption of Profit Motive:

The IRS presumes an activity is engaged in for profit if it produces a profit in at least 3 of the last 5 tax years, including the current year. For horse-related activities, it’s 2 out of 7 years.

 

Example:


Business:

 A freelance photographer markets services, keeps books, updates equipment, and earns profits in some years.


Hobby:

 A person who takes photos occasionally, doesn’t advertise, and consistently loses money while enjoying the process.