How To Figure Out If Your Hobby Is A Business

How the IRS would categorize your favorite pastime

When does your hobby become a business? There are two answers to that question — the one in your mind and the one in the language set out by the IRS. But the latter is really the only one that matters. In fact, in some cases the IRS may consider your photography side hustle, tutoring gig or even your lemonade stand a business; in others the agency is willing to let it slide into hobby territory. What’s the difference? According to the IRS, a hobby is defined as an activity you participate in for “sport or recreation, not to make a profit.” A business is what you do to make a profit. If you want your hobby to stay a hobby, it’s primary purpose has to be something other than making a profit, even if you do earn a little bit of income from time to time.

The other important thing to note is even if you decide that your activity — for lack of a better word — is a hobby, if it generates income, you’re required to report it on your tax return, says Barbara Orser, a professor who specializes in the management of growing enterprises at the University of Ottawa. But the rules for how to report that income and expenses depend on if the activity is a hobby or a business, so let’s slot yours into a category first.

The IRS put together this helpful list of points you can run through to figure out where you fit. Among them:

  • Whether you carry on the activity in a businesslike manner and maintain complete and accurate books and records.
  • 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
  • If you’re nodding your head “yes” to most of these line items, then creating and selling your homemade jewelry — or whatever — is probably a business. Then, there’s the question of profitability. If, specifically, you make a profit in at least three out of the first five years you’re in business, the IRS would consider it a business. Moreover, if you are aiming to make a profit, increase your profits, have done similar activities for profit in the past, or expect to sell the assets you’re creating for profit in the future, it’s probably a business too.

    If you looked at these line items and shook your head “no” — your pastime is likely a hobby. Business losses (for materials, inventory, and other things) can be deducted on your tax return. But not money you lose pursuing your hobby — which is called the hobby loss rule. You can only deduct the hobby expenses up to the amount of the hobby income. Anything in excess of that amount is considered a personal loss and can’t be written off, says New York City-based Certified Public Accountant, Robert P. Russo. Which isn’t to say you should stop making jewelry/taking photos/selling lemonade — only that you should be honest with yourself (and your finances) about exactly what’s going on.

    With Hattie Burgher

    Jean Chatzky

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