From the IRS.gov website...

Abusive Home-Based Business Tax Schemes - Law and Argument

Hobbies

IRC § 183 defines activities not engaged in for profit. Such activities with little or no actual effort to profit from them are deemed hobbies and hobby losses are generally not deductible. Hobby "businesses" often show little or no Schedule C or Schedule F gross income.

IRC § 183(b) limits the deduction for an activity not engaged in for profit. In other words, legitimate expenses related to a hobby activity may be deducted, but generally only to the amount of the income.

Treasury Regulation 1.183-2(b) identifies nine relevant factors to consider in determining whether an activity is engaged in for a profit and no one factor is determinative. The courts have addressed the issue of hobby "businesses":

In Golanty v. Commissioner, 72 TC 411, the taxpayer maintained books and records detailing income and expenses of the business. The court concluded that the books and records represented nothing more than attention to detail because there was no showing that the books and records were kept for the purpose of cutting expenses, increasing profits, and evaluating the overall performance of the operation. The court determined that although the petitioner's activity had some of the trappings of a business, it was not sufficient to demonstrate that the enterprise was a business carried on for profit.

In Ransom v. Commissioner, TC Memo 1990-381, the court found an Amway distributor was not conducting the activity for profit. The court determined that the taxpayer failed to conduct the activity in a business-like manner because the petitioner's costs significantly exceeded the income generated and he made no attempt to cut his costs despite the large losses and failure to recruit others to distribute the products. A further indication to the court was the thin line dividing his personal activities from his business activities because the activity appeared to require little more than maintaining an active social life.

In Elliot v. Commissioner, 90 T.C. 960, the court held that the taxpayer's Amway activity was not conducted as a business engaged in to produce a profit. Rather, the court determined that the petitioner's involvement was motivated by a desire to avoid taxes and that he used his Amway activity as a vehicle for deducting personal and recreational expenses as business expenses.

Here's the link...
http://www.irs.gov/businesses/small/article/0,,id=106518,00.html