The information in this article is up to date for tax year 2023 (returns filed in 2024).
We live in an age when anyone can be their own boss and turn their dreams and passions into a business. Many 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, so figuring out if your activity counts as a business for tax purposes is important.
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 help a brand-new business at a time when 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?
People generally have hobbies for recreation – not to make a profit. On the other hand, businesses operate with the intention of making money. They 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 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. You probably have a business if you answered ‘yes’ to most of these questions. If you answered ‘no’ to most of them, you probably have a hobby.
If you still need clarification after answering these questions, 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. Maintaining these documents 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 must file Schedule SE and pay self-employment tax if your net earnings from your activity are $400 or more in a single calendar year. You’ll also be able to deduct certain expenses considered necessary and ordinary for your business.
Read also: The Basics of Self-Employed Taxes
Are payments through CashApp or Venmo taxable?
Yes! When calculating net earnings, you must consider transactions made on third-party payment platforms like PayPal and Venmo. If your hobby generates income netting $400 (from all sources), the IRS considers it taxable, and you should report it on your tax return.
In fact, the IRS now requires third-party payment platforms to issue Form 1099-K for accounts with more than $600 in total transactions related to your hobby or business. Keep in mind that Form 1099-K will report the gross amount of money you receive.
It does not consider your hobby’s cost of goods sold (COGS). So, when you report the form, you should subtract the cost of the raw materials. However, you cannot access other business expense deductions since you are not operating as a business.
For example, if your hobby is selling baked goods, you could deduct the cost of ingredients. But you could not deduct expenses like the cost of delivering items or fees to be a vendor at a market. Documenting the amount you deduct from your gross earnings is important, just in case you need to reference your deductions in the future.
Note: If you did not receive a 1099-K and you should have or if you have mistakenly received a 1099-K you should contact the app’s support team.
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 tax return. The IRS will automatically tax you as a sole proprietor if you are the only owner.
Learn more: Starting A Business and Wondering About Taxes?
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