Your "business" is really a hobby

audit red flags hobby

Who wouldn't like to turn their favorite hobby into a business? Year after year, taxpayers continue to report losses on their taxes from businesses that are really just activities they like to do for fun.

But the IRS won't be fooled. The general rule of thumb is that if the venture hasn't earned a profit in three out of the last five years, it's usually not a legitimate business.

Dave Du Val, vice president of customer advocacy at TaxAudit.com, represented a client in an audit who had set up a side videography business where he filmed weddings and special events. It was his first year in business and he reported a loss. The IRS came after him, saying it was just a hobby and not a business. But after providing documentation of expenses like advertising costs and showing records of meetings with business strategy experts, it was approved and the client was let off the hook.

First published March 9, 2015: 10:35 AM ET

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