Small Business profitable in third year

[tr3434]

A tax advisor told me last year that a small business would need to be profitable in the third year of filing taxes with the business . What happens if it is not profitable? Do I just owe taxes? I don't understand what he meant. Could you please help?

Thank you

[GabriellaEA]

Hi @tr3434! It sounds like what the advisor was referring to was the IRS guidelines on hobby versus business, although "profitable in the third year" is not a hard and fast IRS guideline for determining whether you have a hobby or a business. The main issue you run into if the IRS considers your activity a hobby instead of a business is that you can no longer deduct expenses from your hobby income. While a small business can take expenses and even losses, hobbies are treated differently. If you'd like to read more about the IRS guidelines for determining whether an activity is a hobby or a business, you can check out an awesome, quick IRS read here.