Are you involved in a dog breeding business or considering starting one? If so, you are in the IRS’s crosshairs. The IRS has long considered dog breeding to be an activity typically classified as a hobby, rather than a business, for tax purposes.
When it comes to taxes, hobbies are usually tax disasters. Unlike a business, you can’t deduct your hobby expenses from hobby income (or any other income). But you must still report and pay tax on any hobby income you earn.
On the expense deduction front, there’s one exception. You can deduct your costs of goods sold for each puppy you sell.
Fortunately, a dog breeder can qualify as a business. You can do this even if you lose money in some years (or even in many years). There are two ways to qualify:
- Profit test. If you earn a profit in three of five years, the IRS must treat your activity as a business.
- Facts and circumstances test. If you can’t meet the three-of-five-years test, you can still qualify by showing that you engage in breeding with a genuine intent to earn a profit. Your goal doesn’t need to appear reasonable to others, but it must be honest and bona fide.
The IRS reviews nine factors to determine profit motive. Three factors carry the most weight:
- Operating in a businesslike manner
- Having expertise in dog breeding
- Devoting time and effort to the activity
To strengthen your case as a business, you should:
- Keep accurate business records
- Market your business consistently
- Consider integrating breeding with related businesses, such as a kennel or grooming service
- Create and follow a business plan
- Commit steady time and effort to breeding
Forming a legal business entity, such as an LLC or a corporation, also reinforces your profit motive.
