Anyone who has ever spoke to me knows that I am an unabashed fan of the Solo-K plan (also known as a Uni-K, self-directed 401(k), self-administered 401(k). Now, my support of the 401(k) doesn’t mean that anyone can establish the plan. One must be self-employed in some capacity and qualify for the plan….as one might imagine, there must be either full or part-time business activities being conducted for that business. This can lead to an interesting conversation with a prospective 401(k) client…do you have a hobby or self-employment?
The IRS has provided greater clarification on whether an individual has a hobby or self-employment by laying out some common characteristics of a hobby. When determining whether you have a hobby or self-employment, you want to make sure that your “business activity” is an actual self-employment activity vs. a hobby. Please note that one characteristic, in and of itself, does not make it a hobby or self-employment, but when you look at all of the characteristics in toto, you should have a better idea whether you have a hobby or self-employment.
- Carrying on an in a businesslike manner? — Again, in and of itself, this characteristic isn’t a firm indicator. But, to you have an office? Do you actually put in a certain amount of time every day/week, etc. for that activity? Do you have presentations you conduct? Or do you just kind of “play” with the activity?
- How much time do you put in to be profitable? — Similar to #1. Are you actually putting in time to conduct this activity or do you just kind of play with it? Working everyday/week with the activity or once a month (if you feel like it)?
- Does the activity wholly or partially support your livelihood? — Do you actually use the receipts from this activity to live on? Or when you make some money, do you just put it back into the activity? It goes without saying that if you live on the receipts from the activity, that might suggest it is self-employment.
- Losing/Spending money…necessary part of the activity? — This one might be tough to define, but are there actual and legitimate expenses you are incurring to become profitable?
- Do you change your activities to increase revenue? — No offense to hobbyists, but we all know our share of hobbyists. Many times a “eh, I play with this when I want….eh, I bring in a little bit of money, definitely not something I could make a living at.” With self-employment activities, you have to figure it out. What do I need to do to actively market my business? How can I increase revenues? How can I bring down expenses? What should I be doing with social media?
- Whether you (or advisors) have the knowledge to conduct your business? — Okay, I would agree, this characteristic is pretty generic. I mean, can one carry on business activity with a brand new business and not be really skilled or knowledgeable in that activity? I would think so…but, again, remember these are characteristics to consider…they are not the be all and end all.
- Were you successful with other similar activities in the past? — I would probably liken to #6 as to its genericness (if that is even a word). Treat it for what it is worth.
- Is your business making profit, and does it vary by years? — Valid consideration. Generally speaking, a hobby is a pursuit of a passion…maybe without any strong concern for making money. I mean if you reallllly have a passion for making model airplanes,, you may not even be concerned with making money. I think all of us would agree that an individual who sells 100 model airplanes for profit on Ebay, may be considered self-employed, compared to the individual who sells 1 but has 100 model airplanes on display in their home for their own viewing pleasure.
- Expecting future profits from your current activities? — You may be involved in an activity of having activities now where you may not make money immediately. Because I love wine, I think about someone who is licensed to produce and sell wine and may make wine that they do not plan to sell immediately. Hobby or self-employed? I think most of us would say self-employed. Also, think of a real estate agent who sells the occasional home. Hobby or self-employed? Well, my guess is that even the least successful real estate agent who sells a minimum number of homes would certainly say and consider themselves self-employed.
The good news is these are simply characteristics to whether you may be conducting a hobby or be self-employed. It is not necessarily the be all and end all in defining empirically whether you are self-employed. But, they are good characteristics to consider. With all of the benefits associated with the 401(k), it is understandable why most individuals would wish to have a business sponsor their own Solo-K plan. Hopefully, these characteristics will assist you in determining whether the activity you perform….is a hobby or self-employed business.
As always, the information provided is intended to be educational in nature. It is not intended, nor should it be interpreted as, any form of tax, legal, financial or investment advice. One must always consult with their respective professional in all such matters.