The IRS recently announced that there is up to $30 billion per year in unpaid taxes due to deductions for hobby activities that have been implemented incorrectly. As a result the IRS is making an effort to educate taxpayers on the difference between a profit for business and a hobby. (This usually means they will begin auditing taxpayers, once they feel sufficient education has been provided)

If your business project is not for profit, you cannot deduct losses for the project to lower your income. The bottom line being, if you aren’t planning on making a profit, then the plan to start a home based business to help lower your taxes, is not for you. A business or project which is operated with the expectation of earning a profit is considered a business for profit and not a hobby. The IRS usually allows a business to show a profit during at least three of five years. If a profit doesn’t occur during this time period, the IRS may question if your home based business is a hobby or for profit?

Due to the era of high technology, individuals can start a home based business for less than $100, and have full expectation of earning a reasonable profit within a set amount of time. Contrary to what others may say, it’s not necessary to start a corporation or limited partnership to go into business. In many states and cities, a business license with approval from the city zoning department will do. The city or county, where you live, will alert you concerning city or business taxes.

The Forms used to report hobby or a business for profit, are very different.

Deductions for hobbies are claimed as itemized deductions on Schedule A (Form 1040) and are limited. Expenses for a sole proprietorship are filed using Schedule C (Form 1040). Any and all necessary expenses to operate your home based business are deductible; including a percentage of your rent or mortgage, utilities and the up keep and maintenance of your home. This also includes expenses such as advertising, your Internet Service Provider, office supplies, marketing material, and a host of additional expenses, including travel, entertainment and car mileage.

Once all your expenses are added up, you may be looking at a sizable amount. And this is one of the reasons, the IRS, in recent years has been reviewing more tax returns of home based business owners. It is important to maintain good records on your expenditures and income, should the IRS have questions.