Small Business or Hobbyist: Which One Are You?

Tips For Taxpayers Who Make
Money From A Hobby

Many people enjoy hobbies that are also a source of income. From painting and pottery to scrapbooking and soap making, these activities can be sources of both fun and finances.

While strolling through an arts festival in the North Carolina High Country this past weekend, I couldn’t help but wonder how many of the vendors were genuine small businesses and how many were hobbyists. Some may have started out as hobbyists and turned something they love into a real business. Either way, there are some important things you should know for tax purposes–the first being whether the activity is a hobby or a business.

Hobby Rules Can Be Complex

The rules for how to report the income and expenses depend on whether the activity is a hobby or a business. If you are a hobbyist, you may not realize that if you make money from a hobby you must report that income on your tax return.

Also, there are special rules and limits for deductions you can claim for hobbies. Here are four things to consider:

1. Is The Activity A Business Or A Hobby

When someone has a business, they operate the business to make a profit. In contrast, people typically engage in a hobby for sport or recreation rather than to make a profit.

There are nine factors you should consider when determining whether your activity is a business or a hobby:

You carry on the activity in a businesslike manner and maintain complete and accurate books and records.
The time and effort you put into the activity indicate you intend to make it profitable.
You depend on income from the activity for your livelihood.
Your losses are due to circumstances beyond your control (or are normal in the startup phase of your type of business).
You change your methods of operation in an attempt to improve profitability.
You or your advisors have the knowledge needed to carry on the activity as a successful business.
You were successful in making a profit in similar activities in the past.
The activity makes a profit in some years and how much profit it makes.
You can expect to make a future profit from the appreciation of the assets used in the activity.

You should base your determination on all the facts and circumstances of your activity.

2. Allowable Hobby Deductions

You can only deduct ordinary and necessary hobby expenses:

Ordinary expense is common and accepted for the activity.
Necessary expense is appropriate for the activity.

3. Limits On Hobby Expenses

You can only deduct hobby expenses up to the amount of hobby income. If hobby expenses are more than its income, you have a loss from the activity. However, a hobby loss cannot be deducted from other income.

4. How To Deduct Hobby Expenses

You must itemize deductions on your tax return to deduct hobby expenses. You should look into this now to determine if you will itemize your deductions when you file your 2019 tax return next year. Expenses may fall into three types of deductions, and special rules apply to each type.

More detailed information about taxes for small businesses and hobbies can be found in the following IRS publications:

Publication 334, Tax Guide for Small Business
Publication 525, Taxable and Nontaxable Income
Publication 529, Miscellaneous Deductions
Publication 535, Business Expenses

For help with these complex tax situations, you should always contact your certified tax professional.