Is a Part-Time Business a Business – or a Hobby?

This post is in: Business
No Comments

If you’re operating an MLM as a part-time business to augment your regular W-2 job, take note! The IRS is taking a look at these businesses with an eye to abusive deductions. If your business doesn’t measure up, you could have a potential problem on your hands.

I just read a recent tax court case about a well-paid engineer, who also sold a health supplement on the side. The network marketing model was one where you sold products, but also worked to bring in other distributors into your downline. According to the engineer’s testimony, the primary focus was on bringing other people into the business, as opposed to selling the products. However, the only people successfully recruited as either customers or distributors were family members.

The taxpayer promoted his business in several ways. He would drop cards on windshields during his morning and evening commutes to his regular job. He would send out direct mail to about 48 people each month, following up with additional postcards, phonecalls and occasional meetings. However none of these efforts resulted in any sales or recruited distributors.

Over an 8 year period the taxpayer reported losses on his tax return of between $2,700 and $12,000 each year. About 5 years into this period the IRS challenged the taxpayer, claiming that his business was nothing more than a hobby and his losses over and above his earned income should be disallowed.

At the trial, the taxpayer could provide no evidence of a business plan, or any formal record-keeping at all. The IRS contended that he really wasn’t engaged in the MLM business for profit.

The Tax Court found in favor of the IRS. They noted that the taxpayer only spent a few hours per week on his MLM business, as compared to his regular full-time employment. They also noted that the taxpayer was a long-time user of the products, and felt this was a significant motivating factor in his decision to sell the products.

Ultimately, the taxpayer did not demonstrate any attempt to make a profit in his business – one of the 9 essential factors to having a real business. After 8 years he wasn’t making a profit, and wasn’t doing anything different to change that. It’s okay to not make a profit, as long as you’re trying. But if you don’t change anything – you don’t get advice or assistance from marketing professions or other people to increase sales, you don’t change your marketing strategy … then it’s going to be hard to demonstrate that you really are serious and in business to make a profit.

Here’s a quick checklist of the 9 factors to having a real business. Be prepared to answer “yes,” to half of them or more … or face some IRS scrutiny!

  1. Businesslike Manner: Do you have a separate bank account, keep accounting records, have a filing system and prepare/review financial statements regularly?
  2. Time and Effort: Do you track your time and appointments, keep notes of meetings and conversions, and record seminars or other business-related events you attend?
  3. Dependence on Income: How important is the income you receive? Do you depend on it to make a living? Do you plan to entirely replace your income with the business income?
  4. Reasonable Losses: Are your losses reasonable for your field? How do they compare to other businesses?
  5. Effort to Make Money: If you have losses, have you made efforts to turn things around? Have you met with advisors or consultants to improve your business?
  6. Experienced Advisors: Do you have advisors and do they have relevant experience for your business?
  7. Your Experience: Have you had any experience in business, or in this business?
  8. Past Profit: Have you had profitable businesses in the past? Have those profits been enough to make you want to continue in business?
  9. Asset Appreciation: Is your business building assets that will appreciate in the future?

Leave a Comment