Running a part-time business on the side can lead to many tax advantages. You may deduct some of the costs of entertainment, for example, as well as a home office, auto use, business travel, etc. However, if the IRS determines that your activities amount to a hobby, not a business, you’ll lose some of the tax advantages.
The tax code says you are presumed to be in a business, not a hobby, if you show a profit at least three years out of five (two out of seven for a business related to raising horses). Many people believe you have to meet this three-out-of-five test to be able to deduct business losses. In truth, if you take your business seriously, you can deduct losses for many years.
To maximize the tax benefits, therefore, you should have a written business plan that forecasts eventual profitability, even if it will take years to reach that goal. You also should have a written marketing plan that’s revised each year. In addition, you should prepare an income statement and balance sheet regularly.
