When Your Hobby Becomes a Business


Q: I am planning to retire next year and want to pursue my canoe-making hobby as a business. My wife is against it thinks I don’t know enough about what can go wrong. What should I know before I startup?

A: There is a media image of entrepreneurship that seems to favor the work of eager, 20-something innovators. Overlooked in the story are semi-retired, second-career entrepreneurs who have finally earned the opportunity to work on projects that carry greater creative satisfaction than their former salaried jobs. 

The reason I used the phrase “earned the right” is because their 30 or 40 years of salaried service have bought them some savings and other forms of retirement income to help pay the bills while they pursue new entrepreneurial endeavors.

I know a lot of younger people who can’t start new businesses because they don’t have any other source of living while the business works toward a profit. You and your wife do which reduces some of the more stressful aspects of startup entrepreneurship.

Your use of the word "hobby" caught my eye. There are a few words and types of business operations that tend to attract the attention of IRS agents. A hobby-oriented business is one of them.

If the IRS rules your sideline business is more of a hobby than a legitimate business, then it will take away certain business deductions and offsets to other income. IRS targets tend to include home-based animal breeders, collectible traders, and artists.

The best way to avoid IRS attention is to report a profit – preferably in any three of five consecutive years, plus:

-If you ever speak with an IRS agent, avoid the word "hobby" in your discussions. Keep the word off of Web sites as well.

-Prepare a business plan that clearly demonstrates the objective of making a profit.  All new businesses should have a business plan.

-Open a business checking account to process income and expenses.

-Prepare financial statements throughout the year to demonstrate ongoing attention to business results. Your business should be more than a spring-time tally of tax deductions.

Just because the IRS may look at the viability of business deductions doesn’t mean that you should not take every legitimate tax deduction you can. According to the IRS’ most recent Statistical Oversight Institute data for 2009, the audit rate for all personal tax returns is 2%.  If you can legitimately save $500, $1,000 or $5,000 in annual tax obligations by keeping good records and maybe even taking a home-office deduction, then do it. At 2% of all personal tax returns filed in the U.S., the odds are overwhelmingly on your side that you won’t be audited. However, the chances of an audit increase further if the tax return (single or joint filing) reports gross income over $100,000.

At last you are in an enviable position to channel all your mature wisdom, management skills and observations about customer needs into a lucrative business. Best of all, you and your wife will own all the financial benefits of your hard work.  Challenge yourself to put as little hard cash into your startup as possible to maximize your potential equity reward.

Susan Schreter is a 20-year veteran of the venture finance community and small business policy advocate.  Her educational work is dedicated to improving startup longevity and operating performance in rural, urban and suburban America.   She is the founder of www.takecommand.org, a community service organization that offers the largest centralized database of startup and small business funding sources in the U.S.   Follow Susan on Twitter @TakeCommand.