The IRS as part of their Tax Tip 2021-94 provided more clarification on the hobby activity and how to report hobbies (Schedule 1, Form 1040, line 8). Note that the IRS might disregard expenses on a business if they consider that it is a hobby or just for the purpose of offset other income and has always reported net losses (over three or more years). The IRS wants to limit or remove any potential personal or hobby expenses offsetting regular income creating a fraudulent business return (i.e. Schedule C).
The IRS provides the following information on the hobby and relevant factors to classify any activity as hobby.
A hobby is any activity that a person pursues because they enjoy it and with no intention of making a profit. This differs from those that operate a business with the intention of making a profit.
In determining whether their activity is a business or hobby, taxpayers must consider nine factors.
These factors are:
- Whether the activity is carried out in a businesslike manner and the taxpayer maintains complete and accurate books and records.
- Whether the time and effort the taxpayer puts into the activity show they intend to make it profitable.
- Whether they depend on income from the activity for their livelihood.
- Whether any losses are due to circumstances beyond the taxpayer’s control or are normal for the startup phase of their type of business.
- Whether they change methods of operation to improve profitability.
- Whether the taxpayer and their advisors have the knowledge needed to carry out the activity as a successful business.
- Whether the taxpayer was successful in making a profit in similar activities in the past.
- Whether the activity makes a profit in some years and how much profit it makes.
- Whether the taxpayers can expect to make a future profit from the appreciation of the assets used in the activity.
All factors, facts and circumstances with respect to the activity must be considered. And, no one factor is more important than another.
If a taxpayer receives income from an activity that is carried on with no intention of making a profit, they must report the income they receive on Schedule 1, Form 1040, line 8.