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Is Your Hobby Becoming A Business?

Most people don’t struggle with filing a tax return. Even small business owners typically recognize what income they need to report, making the process fairly straightforward. Others, however, don’t simply have a job or a business, but a hobby that brings in money for them. The question then arises, at what point does a profitable hobby become a business? If you find yourself in this situation, here are some considerations that might make it easier for your to categorize whether you have a business or a hobby.

Why It Matters

There can be a big impact on the amount of tax you have to pay if you have a business as opposed to a hobby. Businesses are able to take a wide range of deductions, and these are clearly listed on the Schedule C form that small business owners are required to submit with their tax returns. Mileage, the cost of goods sold, advertising and home office expenses are some of the expenses that will magically disappear from your adjusted gross income if you can classify your money-making activity as a business.

On the other hand, if you have hobby, you’ll only be able to deduct certain expenses and only if you itemize your deductions. If you don’t itemize your deductions, you won’t have the opportunity to deduct any expenses. You’ll have to take any deductions in order. First would come mortgage interest and property taxes that are related to the money-making hobby. Next would come things like insurance premiums, wages and advertising costs. Finally, a person engaged in a hobby would be able to deduct reductions to basis of property like depreciation. These deductions cannot exceed the amount of income from the hobby.

What Qualifies as a Business?

The IRS will count some for-profit activity as a business while they will look at other such activities as a hobby. When deciding if the activity is a hobby or a business, the IRS will take several things into account. Here are a few of them.

1. Are you running the activity as a business?

Some things to consider in this regard are whether you’re keeping receipts. Are you keeping books in a serious manner and using them to gauge your business success? The absence of such activity would indicate you have a hobby.

2. Another question to ask is whether you’re earning a profit or you’re just using losses to offset income in another area.

If you’re just using any losses from your business activity to offset earnings from another source, the IRS is likely to look at what you’re doing as a hobby.

3. Yet another area the IRS might raise questions is related to any personal element related to an activity.

Would you do it for fun if you weren’t trying to make money from it? If so, it’s possible the IRS would classify it as a hobby rather than a business. The IRS will also look into whether you’re spending enough time at a given pursuit. Are you just spending a couple of hours on the weekend at making money from a venture, or are you spending hours every evening trying to build your endeavor?

If you’ve been engaged in an activity that’s tried to make money, you’ll be better off if you can classify it as a business. You can still make money from engaging in a hobby. You can also take some deductions related to a hobby if you can itemize your tax return, but you’ll likely have trouble deducting any losses from your income.

About the author

Seattle CPA+John Huddleston has written extensively on tax related subjects of interest to small business owners. He is a graduate of Washington State University and the University of Washington School of Law.