Trade or business is a term the Internal Revenue Code uses constantly and never defines in full. The Supreme Court settled two elements of it in 1987, continuity and regularity of involvement, and a primary purpose of income or profit, and left everything else to be decided on the facts of each case (Commissioner v. Groetzinger, decided February 24, 1987).
So there is no test to look up and apply. There is a two-part floor from case law, statutory definitions that add cases rather than supply a meaning, and a body of facts the answer turns on.
The Court Said the Absence Is Real
This is not a gap someone forgot to fill. The Supreme Court described it as settled and deliberate: the difficulty has not been ameliorated by the persistent absence of an all-purpose definition, by statute or regulation, of the phrase “trade or business” which so frequently appears in the Code, and this very frequency well may be the explanation for legislative and administrative reluctance to take a position as to one use that might affect, with confusion, so many others (Commissioner v. Groetzinger, 480 U.S. 23).
The Court then declined to supply one. It said the difficulty rests in the Code’s wide utilization in various contexts of the term “trade or business”, in the absence of an all-purpose definition by statute or regulation, and in its concern that an attempt judicially to formulate and impose a test for all situations would be counterproductive and unhelpful (Commissioner v. Groetzinger, 480 U.S. 23).
Anyone offering a clean definition of this term is offering something the Code, the regulations and the Supreme Court have all declined to offer.
The Two Elements That Are Settled
What the Court did accept is short, and it is the closest thing to a general rule that exists. To be engaged in a trade or business, the taxpayer must be involved in the activity with continuity and regularity, and the taxpayer’s primary purpose for engaging in the activity must be for income or profit, and a sporadic activity, a hobby, or an amusement diversion does not qualify (Commissioner v. Groetzinger, 480 U.S. 23).
Both elements have to be present. Continuity and regularity without a profit purpose is a hobby, and a profit purpose exercised sporadically is not enough either.
The Court was equally clear that profit alone does not carry an activity across. Not every income-producing and profit-making endeavor constitutes a trade or business, and Congress distinguished the broad range of income or profit producing activities from those satisfying the narrow category of trade or business (Commissioner v. Groetzinger, 480 U.S. 23).
The Holding Carries Its Own Scope Words
The sentence that decided the case is written narrowly, and the last clause is the part that gets dropped when it is quoted. If one’s gambling activity is pursued full time, in good faith, and with regularity, to the production of income for a livelihood, and is not a mere hobby, it is a trade or business within the meaning of the statutes with which we are here concerned (Commissioner v. Groetzinger).
Within the meaning of the statutes with which we are here concerned is a limit, not a flourish. The Court answered for the provisions in front of it and said so.
And it kept the older rule alive rather than replacing it. The Court adhered to the general position of the Higgins Court, taken 46 years ago, that resolution of this issue requires an examination of the facts in each case (Commissioner v. Groetzinger, 480 U.S. 23). Facts and circumstances is the answer, and it is the answer on the Supreme Court’s own authority rather than for want of a better one.
The Statutory Definitions Add Cases, They Do Not Supply a Meaning
The Code does define the term in places, and the definitions that rank as definition pages for this query are the two below. Each adds to the ordinary meaning rather than replacing it, and each carries scope words that keep it where it was written. Neither this pair nor any other is presented here as the complete set: the Supreme Court’s point is that no all-purpose definition exists, and the Code uses the phrase in many provisions that were not surveyed for this entry. Read the scope words on whichever definition you are borrowing.
The general one is one sentence long and adds one thing. When used in this title, where not otherwise distinctly expressed or manifestly incompatible with the intent thereof, the term “trade or business” includes the performance of the functions of a public office (26 U.S.C. 7701(a)(26)). That is the whole of it. It tells you that holding public office counts. It does not tell you what a trade or business is.
Two qualifiers on that sentence are easy to skip. Includes is an expanding word rather than a limiting one, and the definition applies only where not otherwise distinctly expressed or manifestly incompatible with the intent of the provision in question.
The other one is confined to a single section. For purposes of section 513, the term “trade or business” includes any activity which is carried on for the production of income from the sale of goods or the performance of services, and an activity does not lose identity as a trade or business merely because it is carried on within a larger aggregate of similar activities or within a larger complex of other endeavors which may, or may not, be related to the exempt purposes of the organization (26 U.S.C. 513(c)). That is the unrelated business income rule for exempt organizations. Its opening four words keep it there.
Where the Term Does Its Work
The deduction provision is the one most clients meet, and it uses the term without defining it. There shall be allowed as a deduction all the ordinary and necessary expenses paid or incurred during the taxable year in carrying on any trade or business (26 U.S.C. 162(a)). Whether the activity is a trade or business decides whether that sentence applies at all.
The failure mode has its own section. In the case of an activity engaged in by an individual or an S corporation, if the activity is not engaged in for profit, no deduction attributable to it shall be allowed under this chapter except as provided in that section (26 U.S.C. 183(a)). The term is defined by exclusion: an activity not engaged in for profit means any activity other than one with respect to which deductions are allowable for the taxable year under section 162 or under paragraph (1) or (2) of section 212 (26 U.S.C. 183(c)).
There is a presumption that runs on a year count, and it has two sentences. If the gross income derived from an activity for 3 or more of the taxable years in the period of 5 consecutive taxable years which ends with the taxable year exceeds the deductions attributable to that activity, determined without regard to whether or not the activity is engaged in for profit, then, unless the Secretary establishes to the contrary, the activity shall be presumed for purposes of that chapter for that taxable year to be an activity engaged in for profit. In the case of an activity which consists in major part of the breeding, training, showing, or racing of horses, the preceding sentence shall be applied by substituting “2” for “3” and “7” for “5” (26 U.S.C. 183(d)).
The term also gates several definitions the corpus treats separately. It sets the boundary of a capital asset in capital assets, it is the first half of the passive activity test in passive activity, and 26 U.S.C. 199A(d)(1) builds its own qualified version of it, described in QBI deduction and narrowed again in SSTB.
Common Questions
Not a general one. The two statutory definitions surfaced by this term’s own SERP add a case each, public office in 26 U.S.C. 7701(a)(26) and income-producing activity for the unrelated business rules in 26 U.S.C. 513(c), and the Supreme Court described the absence of an all-purpose definition by statute or regulation as persistent (Commissioner v. Groetzinger, 480 U.S. 23).
Profit purpose, and whether the activity is carried on with continuity and regularity. The Court named a hobby as one of the things that does not qualify, alongside a sporadic activity and an amusement diversion (Commissioner v. Groetzinger, 480 U.S. 23). The consequence sits in the deduction rules, where an activity not engaged in for profit loses deductions attributable to it except as its own section allows (26 U.S.C. 183(a)).
The two elements the Court accepted say nothing about customers. They are continuity and regularity of involvement, and a primary purpose of income or profit (Commissioner v. Groetzinger, 480 U.S. 23). The taxpayer in that case gambled solely for his own account and was held to be in a trade or business for the provisions at issue.
Wherever a client’s side activity has to be characterized, and the characterization is not in the records. The client supplies revenue and expenses. What decides the question is how often the activity was carried on, whether it was pursued for a livelihood, and what the client’s purpose was, none of which arrives on a bank statement. Because the answer requires an examination of the facts in each case, the file has to hold those facts, not a conclusion about them.
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