If you love making jewelry, you might want to sell a few pieces at a local craft fair. If you enjoy raising chickens in your backyard, you may sell a few dozen eggs to others in the neighborhood. So are those entrepreneurial endeavors really businesses, or are they merely money-making hobbies?

The difference between a mere hobby and a bonafide business can be a tricky one, and if you fail to understand the distinction, you risk incurring the consequences of the IRS. Claiming business losses for an endeavor that is ultimately deemed to be a hobby is a common trigger for audits - and it could be the start of some very serious hassles for you and your family.

Just how do you determine the difference between a hobby and a business? More importantly, which factors does the IRS use to make that critical distinction? As tax time is fresh on the minds of most Americans, here are some key things to know about businesses, hobbies, and paying taxes.

You Are Required to Report All of Your Income
In some ways, the distinction between hobby and business can be a bit academic, at least where income reporting is concerned. If you make money from your hobby, you are technically required to report the profits on your tax return.

It doesn't matter if the income derives from selling eggs from your backyard chickens, homemade necklaces at the local arts and crafts fair, or anything else. If you make a profit, you are required to report it - and pay taxes on it. You are also entitled to deduct any associated expenses, from feed for the chickens to jewelry-making supplies, so be sure to keep careful records throughout the year.

How You Treat the Business Matters
If you want the IRS to take your business seriously, you need to do the same. In determining whether the endeavor is a real business or just a hobby, the tax agency will look for things like formal bookkeeping procedures, regular accounting, and other signs of business ownership.

The IRS may also consider whether or not the business is formally registered with the state and other authorities. At the very least, you might want to apply for an employer identification number (EIN), a quick and easy process that can be completed right on the IRS website. If you fail to complete these steps, you might have a hard time convincing the tax agency that you are operating a business and not just pursuing a hobby.

The Intent to Make a Profit is Critical
One of the things that trigger audits is taxpayers claiming losses from hobbies they claim are actually businesses. They write off those losses year after year, hoping to escape the scrutiny of the IRS, only to end up in the audit crosshairs.

When determining if it is a business or just a hobby, the IRS looks closely at the intent to make a profit. Even if the business is losing money, the fact that the business owner has a plan for profitability matters, so think about how you run your enterprise and always keep scrupulous and accurate records.

Reliance on Business Income is Also a Factor
When you are pursuing your favorite hobby, you are probably not thinking about paying the bills and making ends meet. The same is not true of business ownership - as the owner of a business, you care very much about the bottom line, and you rely on the income you make to meet your daily living expenses and save for the future.

The IRS will look closely at your reliance on the income generated by the supposed business, and this is another factor in the business vs. hobby calculation. If you can show reliance on the income generated, there is a good chance the IRS will view the endeavor as a business instead of just a hobby.

Determining whether something is a business or a hobby can be a complicated matter, and the outcome will have a profound impact on your taxes and your finances. If you want to stay in the good graces of the IRS, it is important to understand the factors the tax agency uses to make this key determination. The more you know, the easier it will be to file taxes accurately, always an important consideration.

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