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In order to be able to deduct all your business expenses, you must have been engaged in a "trade or business;" that is, an activity that is carried on for a livelihood or for profit. But for some entrepreneurs, particularly those just starting out, the question arises as to what, exactly, a business is.
Does it include those first few jobs or clients you take on in your spare time, to test the waters? Does it include accepting pay for some sideline activity that you enjoy, such as giving golf lessons, assisting in catering or home improvement projects, or providing business advice? What about occasional sales of craft or artistic items?
According to the IRS, to constitute a trade or business, a profit motive must be present (though you may in fact have experienced a loss for the year) and some type of economic activity must be conducted. "Profit" in this context means that you are aiming to achieve a real economic profit, not just tax savings.
There are several issues you may face in determining whether your activities are really a business under the IRS's rules:
- Are you running a business, or will the IRS treat you as pursuing a hobby that generates some income?
- Do your activities constitute one business, or should they be treated as two or more businesses or other activities?
- How is your business identified for tax purposes?
- Did you materially participate in the business, for purposes of passive activity rules?