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Is Your Home Business A Hobby Or A Real Business?

Aug 18, 2007
I attended a very exclusive wealth conference in San Diego last week and one of the keynote speakers did a segment on treating your home business like a real business NOT like a hobby.

Sounds odd right? Who on earth starts a business and doesn't treat it like a real business? You'd be surprised...

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?

We'll let's have you take a quick test. Have you ever said any of the following at any time when you began a business? And be honest...

1. "I'll give it a try and see what happens."

2. "I'm doing this with the idea of making a profit and if I can't make a profit doing this, then I'll find something else to do that will make me a profit."

3. "Let's see if we make any money at it first"

Notice the above words in italics. If you find yourself using any of these words in your business endeavors it may be time to rethink this whole being your own boss, entrepreneur thing. Not to mention, it is a hobby mentality and frankly, is a damaging mind set to be in.

So, do you have a profit motive? Let's see. Here's what justifies a profit motive?

First and foremost, you must never take the approach in questions 1 - 3 above at anytime or you are clearly not serious and will most likely spend more money than you ever earn. And, you must Incorporate your business otherwise you are viewed by the IRS as a sole proprietorship. A sole proprietorship is when you operate your own business without a formal legal entity such as a corporation (Inc.) or (LLC). This is very risky.

When you operate you business as a sole proprietorship there is absolutely NO legal separation between you and your business and you have personal liability for every business debt.

Guess how the IRS feels about this? Yep, hobby. Your chance of getting audited doubles as well. Yes, doubles.

Furthermore, we live in the most litigious society in the world. 4 out of 5 small business fail in their first 5 years. This is a national statistic.

Considering the great majority of new business owners use their own personal money to begin their enterprise, should their business fail, business creditors can now rightfully go after your personal assets.

Not good. So ask yourself 2 questions right now to determine whether or not your home business is a hobby or a real business...

1. Am I taking the "I'll give this a try and see if it works" approach?"

2. Is my business properly structured right now by being incorporated for legitimacy, protection and long term success?

The answers lie right there.

This article is available for reprint or redistribution so long as the author resource box stays intact.
About the Author
Andrew J. Cass is a Home Business Development Expert and Professional Marketing Consultant. He is in the top 1% of income earners in the Home Business industry. To learn insider secrets and powerful marketing strategies from the pros to help you explode your home business empire, sign up for Andrew's FREE cutting edge Ezine at: www.TheHomeBusinessInsider.com
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