We live in an age where anyone can be their own boss and turn their dreams and passions into a business. A lot of Americans have a ‘side hustle’ in addition to their traditional 9-5 job. These side hustles can be anything from teaching gym classes to selling skin care products. You can turn virtually any hobby into a side gig.
Not surprisingly, it’s important to figure out if your activity counts as a business for tax purposes. For instance, if you’re just launching your business and–like most new businesses–you’re reporting a loss due to startup costs, those amounts could actually be deducted on your tax return. This tax break can be really helpful for a brand-new business, where every dollar counts.
Here’s how to determine whether your pursuit is a hobby or a business.
What is the difference between a hobby and a business?
In general, people have hobbies for recreation–not to make a profit. Businesses, on the other hand, operate with the intention of making money, and will report either a profit or a loss at the end of the tax year.
Do I have a hobby or a business for taxes?
To determine if you have a business or a hobby, ask yourself the following questions:
- Do you keep accurate records?
- Do you intend for it to be profitable and does your time and effort reflect that?
- Do you depend on the income from the activity to survive?
- Do you alter your model to try to make your business more profitable?
- Do you have enough knowledge on the subject to turn it into a business?
- Are your losses a normal part of startup costs, or are they due to circumstances you can’t control?
- Have you made a profit doing a similar activity in the past?
- Was this past profit consistent, or did it see more activity in some years and less in others?
- Do you expect to make a profit from the activity in the future?
Try to answer these questions with facts, and be honest with yourself. If you answered ‘yes’ to most of these questions, you probably have a business. If you answered ‘no’ to most of them, you probably have a hobby.
If answering these questions still leaves you confused, consider this: If you made a profit in three of the last five years, the IRS considers your activity a for-profit business. This rule extends to two out of the last seven years for activities involving horses, like showing, breeding, and racing.
If your business isn’t profitable and could be at risk of qualifying as a hobby, be sure to keep extensive records and receipts. Make a short-term business plan to try to increase profit. This is important for your records in case you get audited.
How much money can I make from my hobby without owing tax?
If you earn more than $400 in a calendar year from your hobby, you should file a return and report it as self-employed income on your taxes.
According to the IRS rules, you’ll need to file Schedule SE and pay self-employment tax if your net earnings from your activity were $400 or more. You’ll also be able to deduct certain expenses that are considered necessary and ordinary for your business.
Read also: The Basics of Self-Employed Taxes
Do I need a sole proprietorship or LLC for my side business?
If you’ve determined that you have a business instead of a hobby, you don’t need to rush to establish a business entity before filing a return. The IRS will automatically tax you as a sole proprietor if you are the only owner. For more about this, read My Business Isn’t an Entity Yet. What Should I Do For My Taxes?
How much can I deduct for hobby expenses?
Hobby-related expenses don’t qualify for a tax deduction for tax years after 2017.
For tax years prior to 2018, the IRS wouldn’t allow you to take any losses if your activity was categorized as a hobby. However, you could deduct hobby expenses and other itemized deductions on Schedule A, but only if it was more than 2% of your adjusted gross income – or your gross income minus adjustments to income. Additionally, the amount you claim on an expense could not exceed the total income from your hobby.