Everyone has heard the term “side hustle.” Possibly you’ve started some freelance work on the side to earn an extra paycheck; perhaps you’ve begun an entertainment stream on a popular platform that makes a little money, or maybe you’ve started crafting at local craft fairs. Does that mean that you now own a business? How much money does your hobby need to earn before becoming a legitimate business?
Let’s cover a few basics.
How Does a Hobby Differ From a Business?
The IRS has particular factors that determine whether or not a ‘side hustle’ counts as a legitimate business, and they treat expenses from the two very differently.
Put simply, the difference between a hobby and a business is whether or not the activity earns a profit. Any money earned is taxable income; however, expenses determine how the IRS categorizes the activity for tax purposes.
What Factors Do the IRS Consider When Determining If an Activity is a Hobby or a Business?
There are nine total factors that the IRS uses to determine whether or not a taxpayer is running a business:
- Does the individual operate in a ‘businesslike manner;’ such as completing valid records and books
- Does the individual put in due time and take active measures toward turning a profit?
- Is the earned income used to support the individual?
- Are losses due to a normal start-up phase, or are they from circumstances outside the individual’s control?
- Has the individual made changes to try and improve the activity’s profit?
- Has the individual started a similar profitable business in the past?
- Has the individual’s business been profitable over the years?
- Does the individual expect a profit from the business in the future due to asset appreciation?
How Can I Make My Hobby A Business In The Eyes Of The IRS?
You can take several steps to keep the IRS from challenging whether or not your monetized hobby truly is a business.
- Maintain financial accounts for your business that are separate from your personal finances, such as bank accounts and credit cards.
- Keep accurate bookkeeping and organization of the business.
- Obtain all proper licensing for your business.
- Create a small business plan and stick to it.
- Track the hours you spend working on your business.
- Review the business’s performance on a regular schedule.
- Continue to grow and learn within the business.
If My Activity Is Still a Hobby, What Can I Deduct?
If you cannot correctly grow a hobby into a recognized business, there are still expenses you can deduct from your taxes. These deductions are itemized deductions on Schedule A, Form 1040, and must be in the correct order when filing:
- Any deduction the taxpayer claims for certain personal expenses, such as home mortgage interest and taxes, may be taken in full.
- Any deduction that does not result in property adjustments, such as advertising, insurance premiums, or wages, may be taken next, to the extent that gross income for the said activity is more than the deductions from the first category.
- Any deductions that reduce property bases, such as depreciation and amortization, are taken last. Still, only to the extent gross income for the activity is more than the deductions taken in the first two categories.