Material Participation

What is Material Participation?

Material participation is a set of criteria the Internal Revenue Services (IRS) uses to determine taxpayers’ level of participation in their income-producing activity.

Deeper Definition

The IRS uses the Material Participation test to determine whether a taxpayer’s source of income is generated by actively participating in a business venture or through passive income.

There are seven tests the IRS set to scrutinize taxpayers. To qualify as a material participant, a taxpayer needs to pass only one out of the seven tests. The test is as follows:

Engagement in the activity for more than 500 hours during the tax year.

You did most of the work involved in the business.

At least 100 hours more than any other individual were spent in the activity.

Participation in the activity is significant, and the total value of all the activities you participated in exceeds 500 hours.

You participated in the activity during any five of the preceding ten taxable years.

Your income-producing activity is a personal service, and you materially participated during the three years before the current tax year.

Regular participation in the activity for more than 100 hours during the tax year.

Meeting one of the seven tests in a tax year qualifies a taxpayer to deduct the full amount of losses on their tax returns. However, a drawback to the test is that it is applicable for only a tax year. For instance, if you pass the test this year, next year you still need to retake it.

Generally, any income-generating activity where one’s participation is regular, continuous, and substantial is Material participation. While any income-generating where one’s participation is non-regular, continuous, and substantial is passive participation.