Many people enjoy hobbies that are also a source of income. From painting and pottery to scrapbooking and photography, these activities can be sources of both fun and finances. If you start to make money from a hobby, you will need to report that income on your tax return.
Until 2018, certain hobby expenses were deductible from your taxable income. However, due to the suspension of miscellaneous itemized deductions in years 2018 through 2020, the tax law no longer permits deduction of these hobby expenses. The Tax Cuts and Jobs Act (“TCJA”) no longer allows deductions for miscellaneous itemized deductions. On the other hand, if you operate a business rather than a hobby, the law does allow deduction of certain related expenses.
This begs the question: At what point does your hobby turn into a business?
Hobby or Business?
If someone has a business, they operate it to make a profit. In contrast, people engage in a hobby for sport or recreation. Nevertheless, many businesses grow out of someone’s passion for an activity that they originally did for fun. In order to decide whether a hobby has become a business, consider the nine factors that the IRS will use to make the determination. (“Yes” answers indicate that the activity might be a business.)
- Do you carry on the activity in a businesslike manner and maintain complete and accurate books and records?
- Does the time and effort you put into the activity indicate that you intend to make it profitable?
- Do you depend on income from the activity for your livelihood?
- Are your losses (if any) due to circumstances beyond your control? Or are these losses normal in the startup phase of your type of business?
- Have you changed your methods of operation in an attempt to improve profitability?
- Do you or your advisors have the knowledge needed to carry on the activity as a successful business?
- Have you been successful at making a profit from similar activities in the past?
- Does the activity make a profit in some years, and if so, how much?
- Can you expect to make a future profit from the appreciation of the assets used in the activity?
Don’t Try This at Home
There’s no one answer to the nine questions above that will be determinative on its own. In making the distinction between a hobby or a business activity, the IRS will consider these factors generally and take into account all facts and circumstances. Further, there is a potential for you to fall within a safe harbor under Section 183(d) guaranteeing for the activity to qualify as a business.
If you think that your hobby activity has grown to the point where it has become a business, it’s time to consult your CRI advisor about how to treat the income and expenses for tax purposes.