Let’s face it—hobbies are born of passions, and at some point you’ve spent so much time working at your hobby that you become somewhat of an expert. Experts of some hobbies can make decent money from amateur hobbyists. You may be in this boat (not too bad to get paid for something you’re passionate about), and if you are, at what point does the IRS begin viewing your hobby as a business?
How does the IRS differentiate between a hobby and a business?
According to the IRS, a hobby is an activity carried out without any intentions or interest in profit making. As such, the IRS believes that a hobby remains a hobby as long as it does not earn you any profits over specified periods of time.
So how do you tell when your hobby has become a business? Technically speaking the IRS will consider the following points:
- Are you putting in time and effort in the hobby with the intentions of making a profit?
- Are you relying on the income gained from your hobby for living expenses?
- Are you improving on your activities so as to increase earnings from the hobby?
- Are you knowledgeable in the area of your hobby such as to carry out a successful business?
According to the IRS, technically any hobby making profits for three out of five consecutive tax years is defined as a business.
Tax on a Hobby Considered As a Business Activity
Once a hobby is deemed a business entity, individuals are able to deduct their hobby-related ordinary expenses from their operations on either schedule C or C-EZ of form 1040. While doing this, percentage limitations are not considered.
A Hobby Not Considered A Business Activity
The IRS’s opinion on hobby losses is that losses arising from hobbies should not be used for offsetting non-hobby income. Expenses should only be deducted up to the amount of income raised from the hobby. Such expenses are recorded on Schedule A and have to meet the 2% limit of the adjusted income in order to be deductible.
Work with your Preferred CFO team to help distinguish between hobby and non-hobby expense and income-related items. Keeping accurate records will help when it comes tax time to file with the IRS.