Hobby vs. Business: What are the Tax Implications

Apr 28

During lean times, people find opportunities to turn their hobby into a few extra bucks. Sometimes those opportunities explode into more possibilities than expected. It doesn’t take long before you ask yourself a reality-check question.

Do you have a side hustle or a hobby?

Your answer will drive tax implications that the IRS is interested in. There is far more than fun being involved when it’s time to answer that question.

Determining if you have a hobby vs. a business makes a difference when filing a tax return.

Are you uncertain whether you should pay taxes on your hobbies as if it was a business? Find out more in our hobby vs business financial guide.

Tax Difference Between Hobbies and Businesses

Many people enjoy making some money with their hobby. Some sell crafts and quilts, while others sell services like videography or photography. Regardless of your passion, the Internal Revenue Service (IRS) requires that all hobby/business income is reported.

Businesses and hobbies need different forms added to your tax return. As part of your tax preparation process get clarity from your accountant on which forms to use. They will know which of several ways is best for you to report your income and expenses.

IRS Definitions of a Hobby and a Business

A small business is all about making a profit. A hobby is for recreation and is not pursued for a profit. A key indicator of a hobby is the amount of money made.

The IRS has a list of nine items that determine if you are engaged in making a profit.

What are the Consequences of Being Classified as a Hobby?

You must report 100% of your hobby income on your personal tax return as “Other Income.” This amount will be subject to income tax. The downside is that you won’t be able to deduct your hobby expenses.

If you had a photography business, you’d be able to deduct your equipment purchases. But if it is deemed a hobby, the purchase of equipment no longer offsets the income. This means you are paying taxes on the full 100% of your hobby income.

An accounting team will know how to guide your business away from becoming a hobby.

How to Prevent Your Business from Being Classified as a Hobby?

The IRS has a "safe harbor rule" that presumes a side hustle is a business. The rule tests to see if the activity has made a profit in three of the last five years. Other factors that distinguish businesses from hobbies include:

Managing your activity like a business with accurate books and records.
Striving to make a profit.
Generating the income for your livelihood.
Your losses being from a startup mode or circumstances beyond your control.
You or your overseers having the knowledge to run a successful business.
Showing a history of making a profit.
Converting your appreciation of assets into a profit.