Expenses from an activity conducted as a business (that is, for profit) are deductible even if they exceed the income from the business. If the IRS determines that your activity is not for profit, you cannot deduct expenses in excess of your income, and you can deduct the expenses only if you itemize deductions. In addition, the expenses are treated as miscellaneous itemized deductions subject to the 2-percent floor.
If your activity shows a profit in at least three of the last five tax years, including the current year, the law assumes you're trying to make money. Fail the three-of-five-year test, however, and it is assumed the activity is not for profit (that is, a hobby).
Your year-end planning needs to consider both where you stand on the profit-or-loss front and how you're doing on the three-out-of-five-year test. If you need to show a profit this year to avoid having your activity branded a hobby, you may want to press for collection of any income you're due and put off paying expenses or buying new equipment until the new year.
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