Is it a “Hobby” or “Business”?
Part 2
July 22, 2004
By Jim Harnsberger, Sr. Tax Analyst

SAN DIEGO – The question of an activity being one of a “hobby” or one classified as a “business” involves numerous considerations. The IRS generally takes the position that an activity will be deemed a “hobby” if, in the analysis, the taxpayer fails to demonstrate that a series of objective standards is not met. These are commonly known as the “Nine-Point” test.

The first test to be determined is the legal standard of “profit motive”; the IRS and the courts use a judicially created analysis to determine if the “objectives” of the taxpayer meet the criteria aimed at “profit”. In short the courts have defined this as follows:

The proper test for determining the required profit motive is whether “profit was the dominant or primary objective of the venture.” Hildebrand v. Commissioner , 28 F.3d 1024, 1027 (10th Cir. 1994), affg. Krause v. Commissioner , 99 T.C. 132 (1992); see also Keeler v. Commissioner , 243 F.3d 1212, 1220 (10th Cir. 2001), affg. Leema Enters., Inc. v. Commissioner , T.C. Memo. 1999-18.

In determining this “profit motive” the IRS and the courts use a nine-point test as a standard of objective measures aimed at evaluating aspects of the activity or conduct of the taxpayer to determine if such conduct is in fact, “profit oriented”.

The first test used in this determination and the standard applied is as follows:

1. Manner in Which Activity Conducted
The fact that a taxpayer carries on an activity in a businesslike manner and maintains complete and accurate books and records may indicate that the activity was engaged in for profit. See sec. 1.183-2(b)(1), Income Tax Regs. Also, a profit motive may be indicated by the conduct of the activity in a manner substantially similar to other activities of the same nature which are profitable. Id . Conducting an activity in a manner substantially like comparable businesses which are profitable may indicate that a taxpayer conducted the activity for profit. Engdahl v. Commissioner , 72 T.C. 659, 666-667 (1979). Commingling of funds suggests that the activity is a hobby rather than a business for profit. See Rinehart v. Commissioner , T.C. Memo. 1998-205; Ballich v. Commissioner , T.C. Memo. 1978-497.

Issues for and against the taxpayer, such as commingling of funds can be operational considerations for the taxpayer to evaluate in how the business activity is conducted. What is most important is that in any audit or examination these factors will almost always be determined by the facts and circumstances of every case. The tax professional should be familiar with all of the legal standards applied by the courts and used by the IRS in conducting audit examinations of the business. More weight is given to objective facts than to the taxpayer's statement of intent. See Engdahl v. Commissioner [Dec. 36,167], 72 T.C. 659, 666 (1979); sec. 1.183-2(a), Income Tax Regs.
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