The IRS is really evaluating continuing business losses to see if these are in fact “Hobbies”.    One of the major tests to determine if a business is really a Hobby is to review the past five years of Taxable Income from the business.  If the business shows income 3 out of the 5 prior years than it would be considered a business.

A lot of businesses will be showing losses for at least 2008 and 2009, but there are many more that show losses year after year.  Here are some of the questions the IRS considers beyond the 3 out of 5 years of profit situation:

1. Do you carry on this activity in a businesslike manner with complete and accurate books and records?

2. Do you have expertise in this activity? If not, do you use outside experts or otherwise study the activity in a manner that indicates a profit motive?

3. Do you spend time on this activity? The more time you spend, the more this activity looks like a for-profit activity.

4. Do you expect appreciation in property values to produce the ultimate profits?

5. Have you had success doing this type of thing in the past?

6. Does your history of profits and losses with this activity show that you engaged in this activity for profit?

7. Does the profit you realize or hope to realize justify the losses incurred or expected?

8. Considering your other sources of income, do you need this activity to work for youe well-being? (If you work at this full time and need this work to pay for your household, you pass the business test on this answer alone.)

9. Is your personal pleasure or recreation absent from this activity?

Remember, “yes” answers increase your chances that the IRS will consider your activity a business. You don’t need nine “yes” answers. You might only need one.

If your business is determined to be a Hobby there can be huge tax consequences.  Not only is the loss disallowed (the loss can be a Miscellaneous Itemized Deduction) but the Gross Income from the business is added to your overall income for the Alternative Minimum Tax (AMT) calculation.