Every year hundreds of enterprising individuals decide to take their hobbies to the next level: profit. And why not? In this economy, corporate jobs are anything but secure, startup costs are lower, and everyone is looking for ways to make more money.

I wholly applaud the hobbyist turned entrepreneur. You already have the skills and the passion, so why not make some money from your efforts?

I do, however, want to warn you about one potentially tricky aspect: taxes.

You see, the IRS has a nasty habit of calling many small businesses hobbies. Hobby income is taxable, and hobby deductions are extremely limited. So the IRS has a lot to gain (like your hard-earned cash) by classifying anything it can as a hobby instead of a business.

The IRS states that a hobby is an activity that you do because you enjoy it, regardless of profitability. A business is an activity you engage in for the purpose of making money. In other words, you would not do it if you didn't intend to make money. While this should be clear-cut, it's hard to prove your intentions on your tax returns.

How can you avoid the costly "hobby" designation and make sure your business receives all the tax benefits it deserves?

The basic guideline to be considered a legitimate business by the IRS is to show that your endeavors have been profitable for at least three out of the last five years. Simple enough. However, in this economy, many businesses are not making a profit. So are they all doomed to the "hobby" designation?

Not necessarily. Failing the "three out of five" rule, there are other ways you can show that you intend to make a profit with your activities. Here is what the IRS is looking for:

1. Do you operate in a professional and business-like manner?
2. Do you put sufficient time and effort into an activity to indicate an intention of profit?
3. Do you depend on the income from the activity?
4. Have you changed business methods to improve profitability?
5. If the activity incurred losses, were they due to circumstances beyond your control, or were they incurred during the startup phase of your business?
6. Do you have the business know-how to run a successful business?
7. Have you made profits from similar activities in the past?
8. Have you made profit in some years?
9. Do you expect to make a profit in the future from the appreciation of assets used in the activity?

This list is certainly not exhaustive, but it is a good start. If you can show the IRS that you are working to make your business profitable, proving several of the above items, you will be in a good position to argue the validity of your business and get all the tax benefits that come with it.

Don't let the IRS take the shine off your new business idea. You could be the next Bill Gates, Martha Stewart or even Roni Deutch: people who took something they loved to do and created an entire industry. What are you waiting for?