LAKEWOOD, NJ - Hobby or Business? It's all about the “Pursuit of Profit.”

LAKEWOOD, NJ - Hobby or Business? It's all about the “Pursuit of Profit.”
So, how was business this year? Did you make a profit? If your business is very new, most likely you took a loss. Oh well, at least you can write it off, right?

Well... maybe.

Whether you can write off your business losses depends on whether your business really is a business or a hobby.

"Of course it's a business!", I hear you say. "I don't put myself through this for the fun of it!"

That's what Brenda Konchar thought.

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Brenda Konchar, a Mary Kay Cosmetics representative and Indiana mother of 4, reported her Mary Kay activity as business income.

The IRS disagreed. Konchar took her case to the Tax Court...

... and lost. (See: Konchar and Konchar v. Commissioner of Internal Revenue, (Docket 5388-01S-2004)

So what does it mean?

In a nutshell, if you earn income in the pursuit of a hobby, you can offset the income with deductions. You cannot claim deductions that exceed your income – there’s no loss for a hobby.

However, if you earn income in the pursuit of a business, you can not only offset the income with deductions, you can carry any losses forward. This can be huge for new businesses.

Brenda Konchar had deductions which exceeded her income and reported net business losses for the years 1996 through 1998. The IRS disallowed the losses, claiming that Konchar’s activities constituted a hobby. As a backup, the IRS claimed that even if she were operating a business, her expenses were not properly business expenses.
Here's the important part: The IRS consider a number of factors when determining whether a taxpayer is engaging in a business or a hobby, none more important than profit motive.

The IRS considers that you are engaging in a business when it is your intention to make money. You should be able to demonstrate that you have made a profit for at least three of the last five tax years.

So where did Brenda Konchar go wrong? She didn’t operate her Mary Kay activities like a business. She didn’t effectively promote the business – she didn’t even have business cards – and most of her customers were family and friends. She mixed her business assets with her personal assets. She sold her products to friends at or near cost, and lost money year after year and made no substantial steps to make changes. As a result, her business losses were disallowed.

Here’s the lesson to be learned: if you’re going to operate a business, treat it like a business.

H&R Block does individual returns, as well as business returns: We even prepare C-Corp. And S-Corp. Returns for large national companies.
We even do Small Business Bookkeeping & Accounting.