Your hobby becomes profitable. You’re now a business owner ready to make more cedar furniture easier and open a shop. Great! During 2017’s Small Business Week the IRS tipped its hat to the millions of people who enjoy hobbies that are also a source of income. Their words rang almost poetic:
“From catering to cupcake baking, crafting homemade jewelry to glass blowing, no matter what a person’s passion, the Internal Revenue Service offers some tips on hobbies.”
What happens when your hobby becomes profitable?
The IRS states that taxpayers must report on their tax returns any income earned from hobbies. To make it clearer, the IRS continues: The rules for how to report the income and expenses depend on whether the activity is a hobby or a business. There are special rules and limits for deductions taxpayers can claim for hobbies.
The key to the question: Is it a business or a hobby?
In determining if your income-producing activity is a business or a hobby, the IRS states that a key feature of a business is that people do it to make a profit. If your hobby becomes profitable, the IRS may consider your hobby to be a business before you’re prepared for their intervention. Make sure you know if and when your business becomes profitable and you act before the IRS steps in. People engage in a hobby for sport or recreation, not to make a profit. Consider nine factors when determining whether an activity is a hobby. Make sure to base the determination on all the facts and circumstances.
3 tips from the IRS on hobby expenses:
- Allowable Hobby Deductions. Within certain limits, taxpayers can usually deduct ordinary and necessary hobby expenses. An ordinary expense is one that is common and accepted for the activity. A necessary expense is one that is appropriate for the activity.
- Limits on Hobby Expenses. Generally, taxpayers can only deduct hobby expenses up to the amount of hobby income. If hobby expenses are more than its income, taxpayers have a loss from the activity. However, a hobby loss can’t be deducted from other income.
- How to Deduct Hobby Expenses. Taxpayers must itemize deductions on their tax return to deduct hobby expenses. Expenses may fall into three types of deductions, and special rules apply to each type. See Publication 535 for the rules about how to claim them on Schedule A, Itemized Deductions.
Ask yourself “Am I prepared if my hobby becomes profitable?”
The IRS uses some key factors in deciding whether your hobby is a business. No one factor alone is decisive, and you should consider an overall picture of what you’re doing and if your activity is a business engaged in making a profit:
- Whether you carry on the activity in a businesslike manner.
- Whether the time and effort you put into the activity indicate you intend to make it profitable.
- Whether you depend on income from the activity for your livelihood.
- Whether your losses are due to circumstances beyond your control (or are normal in the startup phase of your type of business).
- Whether you change your methods of operation in an attempt to improve profitability.
- Whether you or your advisors have the knowledge needed to carry on the activity as a successful business.
- Whether you were successful in making a profit in similar activities in the past.
- Whether the activity makes a profit in some years and how much profit it makes.
- Whether you can expect to make a future profit from the appreciation of the assets used in the activity.
Enjoy your hobby, your business and your life. If you’re not sure what the IRS expects from you, contact us. As your CPA and tax professional, we take care of the accounting and tax things in your life and your business.
What’s the bottom line?
We know how the tax laws work. It’s your business and we’re here to help you.