How to Distinguish Hobby Income from Self-Employment Income

Woman turning her hobby into a business

Whether you’re into fixing cars, taking photos or playing music, hobbies are one of the best ways to bring joy and fulfillment into your daily life. You can actually make a few bucks, too, depending on your skill set and level of commitment. But when it gets to the point where you’re generating income from your hobby on a regular basis, it might be time to evaluate whether it’s becoming a business.

Are You Running a Business or a Hobby?

The key differentiator between a business and hobby is not a matter of how much revenue you make but your intent for pursuing a certain activity. According to the IRS, the main purpose of a business is to generate income or profit, while a hobby is done primarily for recreation or pleasure. The IRS provides nine questions to help you properly classify if your activity is a business or hobby:

  • Do you perform the activity in a businesslike manner and keep accurate books and records to improve your performance?
  • Do you invest a considerable amount of time and effort to your make the activity profitable?
  • Do you rely on the income of this activity to support your livelihood?
  • Have you had any losses? If so, were they beyond your control?
  • Did you alter your methods of operation to improve profitability?
  • Do you have the knowledge to turn your activity into a successful business? Have you sought professional guidance to improve your business practices?
  • Have you made a profit with similar activities in the past?
  • Does your activity make a profit in some years?
  • Do you expect to make a profit in the future from the appreciation of assets used in your activity?

Also, the IRS will classify your business as a hobby if you haven’t made a profit in at least three of the last five years. If you’re trying to prevent your business from being categorized as a hobby, make sure to keep receipts and accurate records to show your intent for profit. A written business plan is a helpful piece of evidence, as well.

Can I Deduct Expenses from My Hobby?

Under the Tax Cuts and Jobs Act of 2017, miscellaneous itemized deductions can no longer be deducted for tax years after 2017. This means no hobby-related expenses can be deducted.

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.

The Bottom Line

When it comes to the difference between a hobby and business, it all boils down to profit. Are you looking to make a profit with your endeavor, or are you doing it just for the love of it? Even if you do make money from your hobby, it’s important to consider the nine questions provided by the IRS to ensure your hobby doesn’t teeter into the business territory. If you’re trying to run a bona fide business, consider developing an operations plan and maintain your financial records for the IRS to show proof that it’s not a hobby.

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