Finances of Business vs. Hobby (2024)

I have many folks that I work with who are passionate about some cool stuff- toy trains and art and music. Heck, my wife is one of those amazing artists. Some of these businesses are actually quite profitable.
They have revenue.
They have expenses.
They have a profit.
The IRS loves those businesses because they can TAX those juicy profits. The gray line becomes when there is NOT a profit.
Maybe there isn’t revenue and there are only expenses. Or the revenue is minimal. What if it’s the latter of those two scenarios? What if this business doesn’t have a profit?
Can I still write it off?
Just because a business doesn’t have a profit YET doesn’t mean that you should toss it away and not take the write-off.
As a matter of fact, there are some cases where you should take a tax loss and it’s perfectly acceptable.
Heck, I even encourage you to pursue having a business as one of my

Before we carve into the meat of the article, let’s figure out what the IRS says about this.

There are 9 specific questions that the IRS poses to determine whether or not your business is a hobby:

• Does the time and effort put into the activity indicate an intention to make a profit?
• Do you depend on income from the activity?
• If there are losses, are they due to circ*mstances beyond your control or did they occur in the start-up phase of the business?
• Have you changed methods of operation to improve profitability?
• Do you have the knowledge needed to carry on the activity as a successful business?
• Have you made a profit in similar activities in the past?
• Does the activity make a profit in some years?
• Do you expect to make a profit in the future from the appreciation of assets used in the activity?

So, let’s break this down a little bit.

Question# 1. Does the time and effort put into the activity indicate an intention to make a profit? The key word here is

You need to have documentation that you have INTENTION.
For example, do you have a 1 page business plan? What have you invested into your business? Do you have a website? A Facebook page with active postings? A Twitter account posting your content?
Do you have any products or services? Have you tried to market them?
If you’ve never put any money into marketing the business- for example, you don’t have a website and you’ve never tried advertising and you’ve never tried guest blogging or podcasts- you may have a very difficult time to prove that you intended to make a profit.
Are you just writing off a portion of your house bills or your cell phone or your new computer, but don’t have any activities to point to show that you are INTENDING to make a profit?
Make sure you have documented evidence!
Here’s more from the IRS on this issue…
“An activity is presumed for profit if it makes a profit in at least three of the last five tax years, including the current year (or at least two of the last seven years for activities that consist primarily of breeding, showing, training or racing horses).”
So, unless you are into horse breeding and raising, you could write off at least 2 years of business losses- but once you get into year three… you really have to think long and hard about your intention to make a profit.
The second question can be a key one for continuing the write-offs…

Question# 4: Have you changed methods of operation to improve profitability?
The IRS is also willing to give you a pass if you are trying to do something different.
For example, let’s say that you had a podcast and it wasn’t generating any revenue after 1 year. You would be perfectly in your right to write off the losses.
Let’s say you generated a little bit of revenue, but had losses in year 2. You’re making progress, but you aren’t there yet. That should be fine to write-off too.
Then, in year 3, you change the way you do things. You start sending e-mails to prospective advertisers and you try to find some affiliate deals. You even make some arrangements and put advertisem*nts in your podcast. You write a new book and try to sell the book on your podcast.
In this case, you have documentation in the forms of e-mails, podcasts, and other ways to demonstrate that in fact you changed your operations to improve profitability.
Remember how important documentation is in everything related to the IRS.
Final Thoughts
There are so many amazing opportunities in the world today. You can sell courses on everything from podcasting to land flipping to painting toy trains to underwater basketweaving.
You can seek plenty opportunities outside of clinical medicine.
Pursue them! Go after them!
You can even write them off for a couple of years and who knows, maybe that side-hustle income can skyrocket and even go way beyond the salary of your clinical career.
More Advice by Dave Denniston- The New Retirement and Does Stuff Own You?
For some more tax-saving ideas, make sure to check out 3 Answers to The Tax Questions Physicians Have Been Asking and The Little Tax Secret for Physicians.