Will the IRS consider my business a hobby if I put all income in 401k?

[someone]

Hello. I've heard that if you don't make enough income on your business, the IRS may think it should be a classified as a hobby instead.

My business made a small (so far) income -- less than the 401k contribution limit. If I put all the income in my self-employed 401k, will it look like not a real business, since all income would be deductible?

Would it be better if I only put some of the income in the 401k, and if so, how much is safe to leave as normal income, before the IRS would say the business is only a hobby?

Thanks!

[SusanY1 · Accepted solution]

You can make your full contribution to your 401(k) without too much concern.

Whether the IRS determines your business to be a hobby and disallows losses, is a more complicated process than just the bottom line of Schedule C.  As long as you are able to clearly show an intent to make a profit, you are operating a business and not a hobby. 

If you show a history of losses, particularly large losses, over a period of time (generally three or more years) the IRS may be more likely to look into your situation but the nature of a 401(k) deduction is a bit different than writing off other types of business expenses.  

As long as you keep good, organized records you should not shy away from taking legitimate business deductions just because you worry that the IRS may question them.  It's okay for them to ask the questions that you have good answers for! 

[AmeliesUncle]

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@someone wrote:

Hello. I've heard that if you don't make enough income on your business

 If I put all the income in my self-employed 401k

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Not making a lot of income has nothing to do with being a business or a hobby.  It is how you treat and pursue the activity.  If it is an ongoing activity that is usually profitable, it is almost positively a business.

As for your thought of contributing to a 401k, you are only allowed to do that for a business.  Hobby income does NOT qualify for contributing to a 401k.

[someone]

@SusanY1 Thanks for the detailed answer!

[someone]

@AmeliesUncle Ah, thanks for the note about hobbies not even being allowed to contribute to 401k. (Luckily in this case I think it is a business.)

[Anonymous]

there is a question you have to decide - tax deductible 401k or non dedcutible Roth 401k.