By Matthew R. Staul, EA, MBA
Many individuals find themselves generating revenue outside of their primary source of income, and it is important to determine if that income can be reported on a Schedule C. If the taxpayer’s side operation is intended to generate a profit, and qualifies based on the IRS regulations, then they can take deductions on expenses related to the business. If income is received from an activity that does not intend to turn a profit, then it must be reported as other income on Schedule 1 of the 1040 tax return.
What are the IRS qualifications to be considered a business? (IRS Tax Tip 2022-57)
• The taxpayer carries out activity in a businesslike manner and maintains complete and accurate books and records.
• The taxpayer puts time and effort into the activity to show they intend to make it profitable.
• The taxpayer depends on income from the activity for their livelihood.
• The taxpayer has personal motives for carrying out the activity, such as general enjoyment or relaxation.
• The taxpayer has enough income from other sources to fund the activity.
• Losses are due to circumstances beyond the taxpayer’s control or are normal for the startup phase of their type of business.
• There is a change to methods of operation to improve profitability.
• Taxpayer and their advisor have the knowledge to carry out the activity as a successful business.
• The taxpayer successfully made a profit in similar activities in the past.
• Activity makes a profit in some years and how much profit it makes.
• The taxpayer can expect to make a future profit from the appreciation of the assets used in the activity.
How do you turn a hobby into a business?
If there is a situation where the taxpayer starts to make money through their hobby, and they want to make their operation a legal business in the eyes of the IRS, it would help to take the following steps.
• Create a Business Plan. Creating a business plan will help lay the groundwork for the individuals running the business and should include an executive summary, business description, market analysis and strategy and an operating plan.
• Open a Separate Bank Account for the Business. Opening a separate bank account will help determine what expenses were used strictly for the business, and it will help protect the taxpayer’s personal identity. It also allows the tax preparer to accurately report all income and expenses related to the business.
Matthew R. Staul is an enrolled agent with the Medical Management Consulting Group, Inc., a full-service consulting and accounting firm based in Virginia Beach. mmcgonline.com