Complete Tax

The IRS has defined seven rules to determine if you materially participate in the business. If you meet any of seven requirements, you have materially participated for the year, and you should check the "yes" box, or treat the income or loss items as nonpassive if your business is a partnership, LLC, or S corporation.

1. You participated in the activity for more than 500 hours during the tax year.
   
   
2. You were substantially the only participant in the activity during the tax year.
   
   
3. You participated in the activity for more than 100 hours in the tax year, which was at least as much as any other participant, including employees and independent contractors.
   
   
4. The activity involves the conduct of a trade or business, you participated in the activity for more than 100 hours, none of the other six tests apply, and you participated in all such significant participation activities for more than 500 hours during the year.
   
   
5. You materially participated in the activity for any five of the preceding 10 tax years.
   
   
6. The activity is a personal service activity in which you materially participated for any three prior tax years. A personal service activity is one that involves performing services in the fields of health, law, engineering, architecture, accounting, actuarial science, performing arts, consulting, or any other trade or business in which capital is not a material income producing factor.
   
   
7. Based on all the facts and circumstances, you participated in the activity on a regular, continuous basis during the year, and you participated for more than 100 hours. Your participation in management will not count toward this test if anyone else was a paid manager or spent more hours than you in managing the business.
   
   

If you are married, your spouse's work in the business can be counted towards your own participation hours whether or not you file a joint tax return, and whether or not your spouse is a co-owner of the business.

However, work done primarily as an investor in the business (such as reviewing or analyzing financial statements, or monitoring the finances or operations in a nonmanagerial capacity) does not count toward these tests.

If you do not meet any of these tests, you must treat the activity as a passive activity, and if you have a loss, you may have to complete Form 8582, Passive Activity Loss Limitations.

There is an exception for those who own working interests in oil or gas wells - they may check the "yes" box and complete Schedule C whether or not they meet any of the seven tests.

The seven-part test does not apply to C corporations, including personal service corporations. These corporations face a different set of rules, and we suggest that you consult your tax advisor for more details.