Which Is Your Hobby, Home Business Or Real Business

To my surprise and to the surprise of just about every other entrepreneur at the conference, the IRS is not too thrilled with this approach either. As a matter of fact, they have recently taken a stance on this issue due to the astronomical number of home business start ups in the United States as of late.

In case you didn't know, home based businesses now represent 52% of small businesses in the United States according to Small Business Administration (SBA).

Entrepreneur Magazine recently reported that the home business industry is a $427 BILLION per year industry - more that the pharmaceutical industry, food industry and consumer goods industry combined!

So here's what you need to know.

IRS Definition Of A Hobby:

It is generally accepted that people prefer to make a living doing something they like. A hobby is an activity in which you DO NOT expect to make a profit.

It amazes me everyday in this industry how many people have the hobby mentality and take the "I'll give this a try and see if it works" approach. You know what I'm talking about. We've all been there at one point or another.

Well, I have some disturbing news on taking that approach to running your home business. "If you do not carry on your business or investment activity to make a profit, you CANNOT use a loss from the activity to offset other income."

The crucial distinction between a hobby and a real business is whether you engage in the activity with what the IRS calls a profit motive.

I thought this was fascinating because the amount of people I see each and every day that want to begin their own businesses actually do not really have a profit motive. They think they do but they really don't and in most cases they take the every popular: "I'll give this a try and see if it works" approach.

Most home business owners do not realize that if their business is properly defined and properly structured (more on this in a moment) from day 1, ALL of their expenses are tax deductible against ALL household income. NOT just against the income from their home business.

You may want to read that again. Here is an example for illustrative purposes:

John and Susan Smith earn $80,000 per year between the both of them from their full time jobs. They start their own home business with $2000 and eventually invest another $5000 into their business over the course of the year to get it off the ground. They have now invested $7000 in their first year.

If they have properly structured their business from day 1 and have a profit motive from day 1 then they are entitled to a $7000 tax deduction for the current calendar year.

So instead of John and Susan paying taxes on $80,000 (their combined job income), they would only pay taxes on $73,000 ($80,000 combined job income - $7,000 in home business start up and expenses).

Not a bad deal, huh? Now, if John and Susan earned $20,000 in their home business that year then they would pay their normal taxes on $80,000 from their combined job income (since they do not show a loss). But, they would only be required to pay taxes on $13,000 of their home business income because they had $7,000 in expenses ($20,000 earnings - $7,000 start up / expenses = $13,000).

Do you see the powerful benefits of owning a properly designed and properly structured home business? Ok, so how do you know if your home business is structured properly and NOT viewed as a hobby?

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