Julia Kagan has written about personal finance for more than 25 years and for thedesigningfairy.com since 2014. The former editor of Consumer Reports, she is an expert in credit and debt, retirement planning, home ownership, employment issues, and insurance. She is a graduate of Bryn Mawr College (A.B., history) and has an MFA in creative nonfiction from Bennington College.
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Janet Berry-Johnson is a CPA with 10 years of experience in public accounting and writes about income taxes and small business accounting.
What Is the Profit Motive?
The profit motive is the intent to achieve a monetary gain in a project, transaction, or material endeavor. Profit motive can also be construed as the underlying reason why a taxpayer or company participates in business activities of any kind.
Simply put, the profit motive suggests that people tend to take actions that will result in them making money (profiting). In economic thought, Adam Smith identified the profit motive in his book, The Wealth of Nations, as the human propensity to truck, barter, and trade.
The profit motive refers to an individual"s drive to undertake activities that will yield net economic gain.Because of the profit motive, people are induced to invent, innovate, and take risks that they may not otherwise pursue.Profit motive is also a technical term used by taxing authorities to establish a basis for levying taxes.
Understanding the Profit Motive
Profit motive is thought to be one of the main drivers behind economic activity. Economists have often tried to figure out why people do the things that they do. Some answers point to simple survival. In most situations, people need some form of income to pay for the necessities of life. But what drives some people to take the risk of starting a business or innovating?
The answer can be framed in terms of an individual"s profit motive—the drive to undertake some activity with the hope and expectation of being wealthier for doing so. In this view, the reason we live in a world of smartphones, fast fashion, and matcha lattes is because someone thought they could make money selling them.
The idea of a profit motive was behind Adam Smith"s invisible hand, which suggests that self-interested, profit-seeking individuals are broadly beneficial to society. Smith noted that people seeking profit through the buying and selling of goods, for example, help to effectively distribute capital and goods far better than a political body could.
How the Profit Motive Works
In theory, the profit motive helps everyone from individuals to corporations decide what to do at a particular time. Looking at profit, or the potential for profit, simplifies many decisions. If a company makes five different products and earns most of its profit from just two, then the profit motive view would suggest that the company dump the unprofitable lines and invest more in the profitable production lines.
Similarly, a person would want to focus on the activities or employment opportunities that offer the most return for their efforts. For some people, this will mean the highest paying job. For others, it may mean creating their own enterprise with hopes of a higher income in the future.
The profitability of a particular activity is, in theory, communicated by market signals that ultimately are a function of supply and demand. The higher the demand (or potential demand), the higher the profitability (or potential profitability). When the profitability is high, more people and businesses will seek out that activity.
While the idea of profit being part of the motivation behind all manners of economic activity is not controversial in itself, there has been more scrutiny and analysis around applying it as the only factor in decision making.
Critiques of the Profit Motive
In practice, the profit motive is one of many factors that influences how people and businesses act. People, in particular, make their decisions based on a number of social and personal motivations beyond profit.
People may pick a less profitable activity because it benefits them in other ways that are not measured in terms of money. Businesses, too, are being encouraged not to focus solely on profits, particularly with the push for environmental, social, and governance (ESG) criteria.
The pushback against the profit motive as the main driver behind decisions is often connected back to the fallout of the 2008 financial crisis and the recession that followed. Corporations solely motivated by short-term profits and incentivized to seek them by investment capital wreaked havoc on a highly interconnected global economy.
Although many of the critiques and criticisms were targeted at companies looking for excess profits while ignoring inherent risks, the idea of the profit motive being a benevolent force acting on society was also a frequent target. While the idea of the profit motive is still seen as broadly correct and able to explain economic activity in general terms, it is not meant to be a playbook for companies to use in all their decisions.
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Profit Motive and Taxation
The profit motive is used in a more modest way as a defining factor in tax decisions. According to the Internal Revenue Service (IRS), taxpayers may deduct ordinary and necessary expenses for conducting a trade or business. An ordinary expense is an expense that is common and accepted in the taxpayer’s trade or business. A necessary expense is one that is appropriate for the business. Generally, an activity qualifies as a business if it is carried on with the reasonable expectation of earning a profit, that is, an activity undertaken with a profit motive.
Profit motive is also what separates a hobby from a business in the eyes of the IRS—losses from a hobbyare non-deductible because there is no intent to make realeconomic profit. Since hobbies are activities participated in for self-gratification, losses incurred from engaging in them cannot be used to offset other income. Hobby income, even if occasional, must be reported as “ordinary income” onForm 1040.
Taxpayers used to be able to deduct hobby losses as a miscellaneous itemized deduction on Schedule A, but the Tax Cuts and Jobs Act of 2017 eliminated that deduction.
Another way a business owner can establish profit motive is by showing that they operated for profit under the IRS"s nine criteria profit motive test. The nine critical factors used by the IRS to determine whether a business is run for profit or as a hobby are:
Whether the activity is conducted in a business-like mannerThe expertise of the taxpayer or their advisersTime and effort spent in operating the businessPast success of the taxpayer in engaging in a similar (or dissimilar) ventureHistory of income or loss of the activityAmount of any occasional profits earnedTaxpayer’s financial statusAny elements of personal pleasure or recreation
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