Many people who engage in businesses run from home do so at what could really be called a hobby level. The various tax authorities of western countries all pretty much allow a certain latitude for activities run from home that also make some income, but not much. The US IRS and the Australian ATO amongst others have limits of how much can be earned and still remain in the hobby realm.
This is what the Australian Taxation Office says about whether you are a business or a hobby:
“How do I tell whether I am in business?
There is no simple answer to whether you are in business or not, it depends upon the facts in each case. However, you can use the following questions to help you determine whether your activity is actually a business:
Does your activity have a significant commercial purpose or character?
Do you have more than just an intention to engage in business?
Do you have a purpose of profit as well as a prospect of profit?
Is there repetition and regularity to your activity?
Is your activity carried on in a similar manner to other businesses in your industry?
Is your activity planned, organised and carried on in a business-like manner?
Does your activity have characteristics of size, scale and permanency?
Would it be true to say your activity is really better described as a business, rather than a hobby, recreation or sporting activity?
Each time you answered ‘yes’ to the questions above, it increases the probability that you are in business though no one indicator is decisive, they must be considered in combination and as a whole.”
Source: ATO Website 2009
The Internal Revenue Service of the USA says;
“Generally, an activity qualifies as a business if it is carried on with the reasonable expectation of earning a profit.
In order to make this determination, taxpayers should consider the following factors:
Does the time and effort put into the activity indicate an intention to make a profit?
Does the taxpayer depend on income from the activity?
If there are losses, are they due to circumstances beyond the taxpayer’s control or did they occur in the start-up phase of the business?
Has the taxpayer changed methods of operation to improve profitability?
Does the taxpayer or his/her advisors have the knowledge needed to carry on the activity as a successful business?
Has the taxpayer made a profit in similar activities in the past?
Does the activity make a profit in some years?
Can the taxpayer expect to make a profit in the future from the appreciation of assets used in the activity?
The IRS presumes that an activity is carried on for profit if it makes a profit during at least three of the last five tax years, including the current year – at least two of the last seven years for activities that consist primarily of breeding, showing, training or racing horses.”
Source: IRS Website 2009
As you can see, both tax authorities have very similar ideas of what is a business and what is a hobby. HM Revenue and Customs of the UK is a little more confusing and approaches the issue in several ways, including hobby trades, pet breeding and so on.
Basically though the same thinking prevails. If it is part time, done for fun and barely covers costs then it is most likely a hobby and income derived is not taxable. Of course in that case it often means the expenses incurred are not tax deductible, either.
One of the benefits of being in business is the deductions you can claim for legitimate business related expenses. You can also usually claim a lower rate of tax on profits than you would if that income was salary. A business can run at a loss for several years and depending on the business format, indefinitely in some cases.
Think hard whether your home based business is a true business or a paying hobby. Always get professional advice on all accountancy and tax matters and never, ever try to rip off the Taxman. You will get caught and it is never worth it. The system is there to be used but not abused and there are more than enough ways you can pay your share of tax and not a cent more. Be creative, not criminal.