Is It a Business or a Hobby?
Fun in the Sun or Future CEO: How to Handle Your Money-Making Hobby
If you’re fortunate enough to engage in a hobby that brings you some extra cash- great! You do, however, have to report this extra income on your Federal Tax Return. To report your income correctly, you’ll have to determine if whether your activity is a hobby or a business. So, how do you know if you’re participating in a hobby or actually running a business? Hobbies are typically done for fun, while a business has the intent of gaining profit (at least that’s a major part of it).
If you’re not 100% sure, think about a few of these questions:
Are you putting in time and effort to make it profitable? A good example of this would be an Etsy account. If you like to crochet on the side, and you’ve made an account on Etsy to showcase your work (and sell it!)- you’re treating it like a business.
Are you financially dependent on this activity? Have you made changes to make more money?
Answering yes to questions like these make your extra-curricular a business in the eyes of the IRS. View the full list of hobby versus business questions here: FAQs
The IRS will also view your activity as a business if you show a profit in 3 out of the last 5 years (including this one). Horse racing is considered if there’s profit from 2 out of 7 years. If you’re working sporadically, not keeping records, or frequently offering what you’ve made as gifts, you can consider your talents a hobby.
Business people can claim certain tax deductions that hobbyists cannot, but you can claim ordinary (common) and necessary (needed, or helpful) expenses from your hobby within reason. These deductions can be taken up to the amount of your income. Anything over your income is considered a loss. To get these deductions, you’ll have to itemize your expenses based on 3 categories. The IRS goes into further detail here to help you understand and organize them better.
The IRS FreeFile is available until October 15 (and Paragon is available all the time!) to make organizing and filing your tax return easy. Check out irs.gov for the Free File Fillable Forms.
One of the greatest things about hobbies is that they can turn into businesses! For more tips on how to expand your ever-growing talents, and of course, for tax information in general, contact our expert team at Paragon Accountants.