Hobby vs Business + Effect on Taxes

Hobby vs Business + Effect on Taxes

Do I have a hobby or business?

You found something that you really enjoy doing. You’re good at it. Damn good at it in fact. Word has gotten out and now people are starting to pay you for it. That’s awesome! But is it more than just a hobby – has it turned into a business? This is a common question and an important one for you (as a taxpayer) and the IRS. At what point is a hobby considered a business, and what are the tax implications? Let’s look at more general questions first before diving into the weeds of hobby vs. business.

Do I have to file taxes for my hobby income?

Yes. Anytime you earn revenue, that revenue needs to be reported on a tax return. It doesn’t matter if it is a hobby or a business. If you get paid, you need to report it.

Can I deduct expenses for my hobby?

No. Years ago, you could actually deduct expenses for a hobby. But due to a change in 2018, you can no longer deduct expenses if you consider this income-producing activity just a “hobby.” 

Why does it matter if it’s a “hobby” or “business”?

There are two consequences you should consider : 

  1. You cannot deduct expenses for a “hobby,” so your tax liability will be higher than filing as a business (where expenses would offset your taxable income)
  2. The forms you fill out are different. An accountant or tax software can assist in this area. But if you’re filing your taxes the old fashioned way – on paper – you’ll need to be familiar with the necessary forms. Hobby income is reported on Schedule 1 of Form 1040. Schedule C is used to report profits and losses and deduct expenses for a business.

The Small Business and Self-Employed Tax Center from IRS.GOV has more information (or, ask your accountant!).

So what’s the difference? 

A business operates with the intent to make a profit. People engage in a hobby for sport or recreation, not to make a profit. If you’re still not certain, consider the following questions: 

  • Are you receiving professional advice or assistance? 
  • Are you keeping accurate accounting records and using this info to increase revenue?
  • How much time are you putting in? Is it enough to make sure it is running successfully? 
  • Are you actually doing this to make money? Or are you doing it for fun, and you just happen to make money?
  • Were you successful in making a profit in similar activities in the past.
  • Do you depend on income from the activity for your livelihood?

If your answer is yes to most of these…you have a business on your hands. As mentioned before, this means that you can claim your business expenses and reduce your taxable income. 

Bottom Line

You need to think about your intent with an income-making activity, consider how much money it makes, and the amount of expenses it requires. While you can list hobby income with your “other income” without paying self-employment taxes, keep in mind that you cannot claim expenses. If your income is significant, your expenses are significant, or you intend to make a profit, it’s time to call your former hobby a business. 

If you’re looking for additional tax information, check out our articles on the home office deduction during the pandemic, pandemic-related tax deductions (or not)tax planning explained, and preparing to file 2020 taxes.

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