If you are a regular taxpayer probably you would beware of the fact that taxpayers treat hobbies and businesses in a different way. For starters, this article tries to explain how both of them are different from the perspective of tax payments.
Let us consider two examples to understand this case better.
Example 1: Assume that a particular individual is an Assistant track coach at a University, athletic coach for Nike and is associated with a lot of other coaching events related to tracking and field events. The individual is also into private coaching activities that help the individual earn money. Over the past decade, the individual has incurred huge losses. So according to Section 183 of the IRC, if the individual’s income is more than the deductibles, then it is taxable. Else the activity is considered a hobby and is exempt from tax though it is considered a ‘for profit’ activity. Some of the factors that weighed in favor of the individual were that his income was less than the deductibles and also the individual had devoted a large portion of his personal time to the activity which affected the individual’s marriage and life.
Example 2: In this case, let us assume that the individual has been a very successful salesperson professionally and operated a sprint car racing activity as a hobby. The individual had a passion for racing activities and was actively involved in racing for various groups in the early days of his career. Finally, after racing for a few years, the individual purchased his own racing equipment which included a fleet of cars, a full-sized semi-trailer and a shop that was taken on lease. Recently when an audit was conducted, the individual claimed that he had incurred continuous losses for over a decade and hence could not pay taxes. The tax court, taking into account the maturity level of the activity and the sustained losses incurred by the individual ruled in favor of the individual. The court placed particular emphasis on the fact that that taxpayer indulged in the racing as a hobby and did not have an honest objective or goal to make profits through the activity. This is a classic ruling wherein the tax court clearly differentiated between a business and a hobby based on the intent and the profit motive of the individual.
For taxpayers, it is essential to know the difference between a business and a hobby as the tax implications may vary depending on the context. Anything to do with a profit motive and where the income is more than the deductibles, the case gets slotted under a business rather than a hobby because there is money incurred as profit by the individual. A hobby is something that is purely pursued out of passion with no regard to profit and loss.
If you are still confused, you could take the help of qualified CPAs to understand the context and the tax liability owed to IRS. It is always better to get things sorted out earlier than to struggle through after an audit by the IRS.