Tax Matters: What is a hobby vs. what is a business?
Millions of people enjoy hobbies that are also a source of income. 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.
Taxpayers must report on their tax return the income earned from hobbies. 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. Here are things to consider:
Is it a business or a hobby?
A key feature of a business is that people do it to make a profit. People engage in a hobby for sport or recreation, not to make a profit.
Consider the following nine factors as set forth by the IRS when determining whether an activity is a hobby. Make sure to base the determination on all the facts and circumstances.
- Whether you carry on the activity in a businesslike manner and maintain complete and accurate books and records.
- Whether you have personal motives in carrying on the activity.
- 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 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.
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.
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