Making money doing something you love can be fun. Hobbies like Singing, Dancing, Photography, Handmade Crafts, just to name a few, can sometimes help you to earn some nice extra cash on the side. But did you know that your Hobby income is taxable income? This is why it is important that you are clear on whether or not you are actually running a business or enjoying a hobby.
When it comes to dealing with the IRS, it is important that you are crystal clear because money that you earn in either case – Hobby or Business – are both taxable income. Both also actually entitle you to deductions, but let me explain a bit about some of the differences.
tA Hobby, for example, is an activity you’re doing without the intent to pursue a profit…pretty much for leisure and recreation. But don’t be mistaken, if your hobby is producing some sort of income, the IRS requires that you report it. As we both know, hobbies can be expensive. Let’s take one of the above examples…let’s take a closer look at Photography. A Photographer who is doing photography in his or her spare time can be considered a “hobby” photographer. But maybe this photographer takes his or her hobby serious, and finds himself or herself spending a good amount of money on equipment. Unfortunately, if you happen to spend more than you made in a year, you can only deduct expenses “up to” the amount of income you earned when you were performing the photography activities.
Now a business on the other hand, is something you do “with an intent” to pursue a profit, and in this case, the IRS does allow you to deduct ALL of your expenses (as long as the expenses were ordinary and necessary for your profession) even if you wind up spending more than what you made.
The IRS uses several factors to kind of determine whether or not you are in fact “from their perception” running a business or a hobby.
- Do you carry on the activity in a business-like manner?
- Do you maintain complete and accurate records?
- Does the time and effort you put into the activity indicate that you intend to make it profitable.
- Do you or your advisors have the knowledge needed to carry on the activities to create a successful business?
- Do you rely on the income from this hobby for some or all of your livelihood?
These are just some of the IRS assessment questions so you should definitely familiarize yourself with them.
Once you assess your overall actions, you should decide how you want to move forward. If you decide that you are fine having fun as a hobby, just understand that you will be limited in claiming the losses from that hobby. But if you are running a business or want to convert your hobby to a business, then begin taking immediate actions to treat your business like a real business.
Taking actions such as naming your business and registering yourself as a DBA or LLC is a good first step. You should also obtain an EIN from the IRS. Also open a business bank account and begin to regularly use it. Perhaps you should also set up a website or a business social media account on Instagram or Facebook. Also keep track of your financial transactions.
There is so much more to converting your hobby into a business including beginning to change your mindset, learning how to market yourself to attract more customers and clients, and managing your time with a work-life balance but one thing is for sure, definitely make sure you do research and even speak with a professional so that you can start to understand your tax affairs. Having a basic understanding will go a long way.
If this is your first year as an Entrepreneur, check out my Tax Season SURVIVAL Guide – Entrepreneurs Edition so you can go from confused to having clarity, sleep better at night and keep more of your hard earned money.