Many people will file articles of incorporation, articles of organization, and the likes. This document is one of the first steps in forming your new business. Most people don't know that this is just the start of the business. You will undoubtedly have expenses involved in starting. Most businesses don't make it past a few years. Most businesses are started with something the owner loves to do. Here are some things to do in order to assure your business doesn't fall into the category of hobby income.
Hobby income is income from activities that are considered hobbies. It may be maintaining a home aquarium, selling lemonade, babysitting, etc. Under the IRS rules, you must report any income that is not specifically excluded. Hobby income needs to be reported, but any associated expenses can't be claimed against the income. Business income is income derived from the activities of running a business. This business could be the same as the above mentioned; the only difference is expenses against the business are allowed.
Many people, who don't have their taxes prepared by a professional, may fall into the trap of reporting losses to reduce other income. The first few years of a business are usually hard. Most business owners put whatever money they make right back in to the business in order to help it grow. The IRS contends you are allowed have a loss 3 out of the last 5 years. If it extends further than that, they can determine your income to be hobby income.
When starting a business, proper planning needs to be done. If you properly plan out how your expenses should run and how much income you plan on having, you can avoid the IRS categorizing your business as a hobby.
Start up expenses should be amortized- Generally start up costs can't be recovered until you sell the business unless you amortize them
Know what to spend money on that will give you the greatest return- If you keep track of your marketing efforts, you will have an idea of how much they bring in.
If you are on your 3rd year and you have not turned a profit, be careful of any unnecessary expenses the next year, because you may fall into the hobby income category.
I believe the IRS has been fair in establishing this rule of conduct. After all, you get into business to make money. If you go too long and don't turn a profit, the IRS looks at it as if you are doing this for fun. Remember, proper planning and execution of that plan will help you avoid this.
About the Author:
Joseph Weber is an accountant who has extensive experience in tax matters. Please visit my Hobby Income for more information on services.
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