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Guidance on separating business activities from hobbies

Imagine a New Jersey resident who enjoys and excels at baking. The person often bakes large quantities of cookies for bake sales, the person's children's activities and for friends and family members throughout the community. From time to time the resident is given money or goods in exchange for the baked goods and the person periodically replaces the bowls, spoons and baking sheets with new ones in order to produce the best quality cookies that the individual can. Based on this scenario, is this individual engaged in a baking business or just a serious baking hobby?

The answer to that question can have significant ramifications for what, if anything, the individual may claim as business expenses on her taxes. Many people make claims on their taxes each year that erroneously classify hobby costs as business costs and then must correct those errors later on. Thankfully, the IRS has provided some guidance that can help individuals determine if they are engaged in a business or only a personal hobby.

At the heart of whether an activity is considered a business or simply a hobby is whether it generates any profits for the individual. If the individual needs the income from the activity, or if the individual undertakes the activity in order to earn a profit, then it is likely that the person's efforts are business activities. The IRS may also look at if the individual has made profits doing the activity in prior years and if the individual has modified his practices to increase or improve profits in the future.

As the facts of every scenario will dictate whether an activity is a business or a hobby, individuals with questions about this important topic should consult with business attorneys to learn more about it. If they find that their actions do arise to the level of business activities then they may be able to modify how they file their taxes to account for business related expenses. They may also wish to further develop their businesses by selecting entity types that meet their needs, making business plans and protecting themselves from business litigation with the help of legal professionals.

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