You may not know this, but the IRS does not allow taxpayers to claim deductions for business expenses if the IRS believes that the taxpayer is conducting a hobby and not a business. If it is determined by the IRS that the taxpayer has been taking deductions for expenses that relate to a hobby and not a business, there can be severe tax consequences.
Testing Hobby Losses
The IRS will determine if you have conducting a business by determining whether there is a profit motive present. A profit motive basically means that you are conducting your business in the attempt to make a profit and not a loss each year.
If the taxpayer earns a profit in three of the last five years, it is presumed that the taxpayer is in fact conducting a business with a profit motive. If you continue to make a loss each and every year, the IRS will determine that you are conducting a hobby and disallow you from claiming deductions.
In the event the taxpayer does not qualify as having a profit motive present but is in fact trying to earn a profit, they can file Form 5213 (Election to Postpone Determination as to Whether the Presumption Applies That an Activity Is Engaged in for Profit). This form will basically give the taxpayer additional time to prove to the IRS that they are indeed conducting a business with a profit motive and not a hobby.