Wednesday, May 9, 2007

Business or Hobby?

An article in today’s WSJ reminds me of an ongoing discussion I am having with a friend who has a website business. Recent legislation is making the distinction between business & hobbies a little grayer. The IRS published a fact sheet in April that is supposed to clarify the rules:

In general, taxpayers may deduct ordinary and necessary expenses for conducting a trade or business…. Generally, an activity qualifies as a business expense if it is carried on with the reasonable expectation of earning a profit.

My friend’s website has reviews and commentary about dining and night life in New York City. For site content, he goes out and spends a lot of money on dining and night life. He wants to write-off all of these expenses on his Schedule C.

The site is actually very good – it contains detailed reviews for each restaurant and night club – and it is updated frequently. It has the prospect of making money because there are Google advertisements on the site.

Would the IRS consider this a business or a hobby?

Assuming everything is well documented, it would probably depend on whether this business has any prospect of ever turning a profit. The IRS will consider it a for-profit enterprise “if it makes a profit during at least three of the last five years, including the current year.”

I won’t venture a guess as to the likelihood this website will ever generate a profit, but the fact that he is trying really hard should be enough to allow the deductions on his Schedule C… at least for a few years. The main advice I gave my friend is that he’d better keep meticulous documentation of every single expense. Since he probably will get audited next year, the only way he stands a chance is if he can produce comprehensive books and records of his “business.”

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