Most of us have some sort of hobby that they enjoy, and there may come a time when you decide to monetize it. However, when you cross over from a fun hobby or passion project into a business, there are several important considerations from an IRS standpoint.
So, if you’re baking specialty cupcakes, designing fishing lures, or sewing baby quilts and offering them to others for profit, you’ll have to report your income when it comes tax time. But the way you report that income and the specific rules depend on whether it’s truly a hobby or actually a business, with the IRS offering clear guidelines to make that determination.
In general, people undertake a hobby for pleasure, recreation, or because they love a sport or activity. But the sole purpose of a business is to sell products or services and earn income.
According to the IRS, there are 9 ways to distinguish between a hobby and a business:
- Do you treat the activity as a business, including keeping detailed bookkeeping?
- When you invest time and effort into the activity, do you expect to make a profit in return?
- And are you counting on that profit to make a living and pay basic living expenses?
- If you incur losses, are those due to circumstances beyond your control or are they typical for new businesses?
- Do you alter your systems and operations as a means to increase your profits?
- Do you and your trusted advisors have business experience and knowledge about your activity?
- Have you worked with similar activities in the past and make a profit?
- Does your activity earn a profit in most years, and how much does it bring in?
- Do you own certain assets used to perform the activity (like equipment) that will appreciate and yield a profit in the future?
- When we plan your tax strategy and file your returns, we’ll look at your activities through the lens of those nine questions to clarify if it’s a hobby or a business.
For more information about hobbies, business formation, and tax considerations, you can refer to these IRS resources:
- Publication 525, Taxable and Nontaxable Income
- Publication 529, Miscellaneous Deductions
- Publication 17, Your Federal Income Tax
Click here to schedule a consultation with my office and go over your activity or hobby to see if it should be treated as a business.