If IRS decides your business is a hobby, does that mean audit and/or a penalty?

[Regsa]

If IRS decides your business is a hobby, does that mean an audit and/or a penalty?

Or do they just send you a letter disallowing your Schedule C business deductions, without penalty and without audit?

[Regsa]

Thanks Champ. My estimated tax payment is large enough to cover the tax if my deductions are disallowed. I am more concerned with the audit and penalty. Are these likely and is the penalty large? My business is very small and in a foreign country. And if I decide the risk of penalty is not worth it, and decide not to take the deductions, what do I do? Do I just not file a Schedule C at all? Or list the loss in Schedule C but then don’t take the loss on Schedule 1 (Form 1040), line 3, and on Schedule SE, line 2? Thanks again.

[Regsa]

Also, I don’t see anything on the link you provided that talks about the 3 out of 5 year rule (it’s a business if you show a profit in 3 out of 5 years) I thought that was the main rule. Anyway, my business was dormant in its first 2 years with 2 dormant 8858s filed; 2023 was the third year of the business and first year the business became active, but still no profits, just expenses. If I explain this in an attachment, do you think it makes a difference?

My main concern is that if there’s any chance of penalties, it’s not worth it to me to try to take the loss.

[Regsa]

It’s definitely a business, it’s just been slow getting started. It’s registered as a business in both the country where it is located and in the US. It has an EIN number. It just hasn’t made a profit yet, but I intend it to make profits in the next year.