Qualifying for Material Participation
The IRS has seven tests for determining material participation. You only have to meet ONE of them EACH YEAR to qualify for nonpassive treatment of income and losses. This is an easy hurdle to get over. For example, one of the tests only requires you to participate an average of 10 hours per week.
Seven Material Participation Tests
Remember, you only need to meet ONE of the seven tests EACH YEAR to qualify for nonpassive treatment of income and losses.
- You work in the activity for more than 500 hours per year, or
- You worked at least 100 hours, if no other shareholder worked more than that.
- If you have several activities, and spend more than 100 hours in each activity and the total hours for all activities add up to more than 500 hours, you are treated as a material participant in each activity. This is called the significant participation test.
- Your participation in the activity for the tax year constitutes substantially all of the participation in the activity of all individuals, including non-owners, for the year.
- The facts and circumstances show that you worked on a regular, continuous, and substantial basis (IRC Section 469 and Reg. 1.469).
- You materially participated in the activity for any five tax years during the 10 tax years preceding the tax year in question. The five tax years do not have to be consecutive.
- In a personal service activity, you materially participated for any three tax years preceding the tax year in question. The three years do not have to be consecutive. Personal services include, accounting, law, health, engineering, actuarial science, architecture, the performing arts, consulting, or any other trade or business in which capital is not a material income-producing factor.
For Freelancers and independent Contractors
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- Return to the Tax Basics for Startups Table of Contents to find related links.