Sometimes this line is clear and sometimes it's a bit fuzzy. The IRS cares whether or not your activities are a hobby or a business because business expenses are deducted differently than hobby expenses.
Ask yourself the following to determine whether your activities are a hobby or a business:
1) Is the purpose to turn a profit?
If you are starting a business, the purpose should be to create a profitable venture. Even if you setup a 501(c)3 (non-profit), the goal of the activities should be to break even or to turn enough of a profit to grow the organization.
2) Have you been profitable at least 3 of the last 5 years in business?
This is most important to the IRS. The profitable years do not have to be consecutive, but if the organization is not profitable at least 3 of the last 5 years, the IRS can deem your company a hobby. Turning even a small profit is evidence of a business.
3) Are you seeking professional advice to improve best practices and stay in compliance?
Are you focused on improving, growing and running the organization effectively? This is proof of a business. A hobby looks more like a favorite past-time.
4) Are you keeping accurate books and using the information to improve performance?
Setting goals, tracking financial information and using that information to make business decisions shows you have a business and not a hobby.
5) Are you solely using these business deductions to offset another source of income?
Is the main goal of the organization to offset income from another source? If so, this is a hobby.
Maybe you've deemed that your organization is a hobby - but you still have income to report. Per the IRS, you are allowed to deduct expenses up to the amount of the income received from the hobby.
- Allowable hobby deductions are expenses that are ordinary, common and necessary for the activity.
Specific rules apply to these hobby deductions so be sure to consult your tax professional. More on the IRS website here.