Non-Deductible Business Losses – the Hobby Loss

As you know, business losses are deductible on a corporate tax return or on schedule C of a personal tax return.  However the IRS looks closely at losses, especially on Schedule C, and may determine them to be “hobby losses” under certain conditions thereby denying the losses as a deduction.

The IRS looks at several factors to determine if the losses are associated with a bona Fide business.  Some of these factors are:  (1) Has the business made a profit in at least two of the past five years?  (2) Is there a separation of business and personal bank accounts?  (3) Does the business have a written business plan?  (4) Does the business have adequate records to substantiate time spent on the business?  (5) Does the business keep accounting records to show how profitability is determined?  (6) Can the business demonstrate that accepted economic, business or scientific practices have been studied or followed?  (7) Has the taxpayer ever owned or operated a successful business venture in the past?

If several of these factors (especially No. 1) are answered “no” then the odds are very likely that the IRS will find that the enterprise is more of a “hobby” than a business and will deny the business loss.  In addition, if the examiner finds the year under examination to contain only hobby losses she will probably expand the audit to include several other years.