Many people enjoy several different hobbies over the years. Earning a side income from one of your hobbies is also something you may have thought of. But how do you know if your hobby is a business? Or is your business really just an expensive hobby? Typically, an activity is considered a business if it is done with the expectation of making a profit, while a hobby is considered a not-for-profit activity.
How to Tell If You Have a Business or a Hobby
The IRS distinguishes between legitimate businesses and hobby activities for the purpose of taxes. The agency considers a business as a for-profit entity and a hobby activity as a not-for-profit activity. The IRS has a list of nine factors to be used in determining whether an activity is a legitimate business or a hobby:
- Do you keep good business records, have a business checking account, and generally run your activity like a business?
- Do you put time and effort into marketing and other activities to bring in customers?
- Do you depend on the income from this activity for your livelihood?
- Are your business losses beyond your control or typical startup losses?
- Are you motivated by personal pleasure or recreation?
- Do you have business expertise and hire competent business advisors?
- Have you been successful in similar businesses in the past?
- Do you make a profit in some years and how much?
- Can you expect to make a profit in the future?
Why Does the Difference Matter?
The difference between a business and a hobby is important to understand. A business can offset income with all ordinary and necessary expenses. Businesses can deduct operating losses against other income and even carry the losses forward to offset income in future tax years.
Hobby activities come with more limitations. Before the Tax Cuts and Jobs Act (TCJA), you could deduct hobby expenses as itemized deductions, but only up to the amount of hobby income you made. These deductions, along with other miscellaneous deductions, were subject to 2% of the adjusted gross income limitation. Since 2018, these miscellaneous “2%” deductions are not allowed, so hobby expenses are no longer deductible.
Turn Your Hobby Into a Business
If you have concluded that right now, you do just have a hobby, how do you turn that into a business? First, consider if you have the time to dedicate to growing and investing in making it a full business. If not, you might want to keep it as a hobby that brings you occasional income. Then, it may be time to talk to someone with knowledge about starting a business – such as one of the team members at Hayes & Associates.
We Are Here to Help!
Think you might be at the point to take your hobby into a startup? If so, we’re here to help. When you’re ready, we can sit down and map out a plan to get things off the ground and move forward with your own small business. We’re always here to help. Call us at (402) 390-2480 or (712) 322-5503 or fill out a complimentary consultation form on our website.