Do You Have a Business or Just a Hobby? When it comes to taxes, knowing the difference could mean the difference between complying with the law--or breaking it.

If you're making money at whatever you do, the IRS reallydoesn't care if it's a hobby or a business. They want theirmoney. "Gross income," as the IRS defines it, includesincome "from whatever source derived." So let's sayyou're a coin collector. You sold two coins on eBay last yearjust to get them out of your collection, and you made $100 profitdoing so. You should report the $100 as income on your tax returnthis year.

The "business vs. hobby" distinction truly comes intoplay when you lose money. So, in my example above, if youlost $100 when you sold the two coins on eBay, the IRS wouldn'tlet you deduct the $100 against your income from other sources,such as your day job. You can only deduct "hobby losses"against gains from the same hobby. So if this year you sell fivecoins on eBay, making a $200 profit on two of the coins and a $200loss on the other three, you can "net" the loss againstthe profit and report zero income from your hobby.

A professional coin dealer doesn't have to worry about thisbecause he or she is clearly engaged in a business. How do you tellthe difference, especially when the business involves buying andselling stuff, something that many people do as a hobby--such asselling coins or antiques on eBay; breeding cats, dogs or otheranimals; making arts and crafts for sale at craft shows; publishinga newsletter; participating in various kinds of home party saleswhere your main objective is to get discounts on the products; andother activities where your primary objective is personalsatisfaction rather than economic gain.

Under a long-standing IRS rule, you're considered a"business" if you made a profit in three of the past fiveyears, including the current year. But what if you are juststarting out and are likely to lose money this year?

Don't lose hope. You may still be considered a"business" for tax purposes if you can prove to the IRSthat you're taking your activities seriously and are treatingthem as a business with the primary goal of making a profit . . .eventually.

So what sorts of things do you need to do? At a minimum, youshould have a name for your business, some stationery, invoices, aseparate bank account, separate books and records, a place in yourhome that's used only for this business activity, and somerecords to show that you're spending some time working on thisactivity on a regular basis. For example, if you're a coincollector turned coin dealer, you should keep thorough accounts andrecords, advertise in hobby publications, attend coin showsregularly in your area, and consider forming a corporation orlimited liability company to run the business.

You should also consider preparing a formal business planshowing your projected income and expenses over a five- or ten-yearperiod--with some profit at the end of that period. It would alsohelp if you could show that you're actively studying andlearning how to be financially successful in your business.Attending seminars, subscribing to trade magazines or newsletters,buying (and reading) books about the business and consulting withvarious professionals will also help.

Oh, and try not to look as if you're having too much fun. Ifthe IRS audits your business, and the walls of your home office arecovered with rock concert posters, you're toast. Unless, ofcourse, you're dealing in vintage rock posters.

Cliff Ennico is a syndicated columnist, author and host ofthe PBS television series MoneyHunt. This column is nosubstitute for legal, tax or financial advice, which can befurnished only by a qualified professional licensed in your state.Copyright 2005 Clifford R. Ennico. Distributed by Creators SyndicateInc.