picture of tax withholdings form

In recent years, especially 2020, many taxpayers have cultivated a wide variety of hobbies into money-making ventures to satisfy an entrepreneurial spirit or to supplement their household income.  These hobbies span from photography and music, to cooking, baking, sewing, carpentry, and so much more.

But when it comes time to file taxes, often the taxpayer is in an unknown gray area with many questions such as: At what point is this activity no longer a hobby and becomes a business?  Whether hobby or business, do I claim expenses or income from the efforts around this activity? 

What is considered a hobby or a business?

The distinction between “hobby” and “business” can be a very fine line.  To the IRS, a hobby is an activity for recreation that can make money.  A business is an effort where you’re objective is to make money.  The difference is in the intent of pursuing the activity.

The IRS Code Section 183 offers some guidelines which can help you to determine if your hobby is a business.  This nine-point test attempts to pinpoint your intent.

“Deciding whether a taxpayer operates an activity with an actual and honest profit motive typically involves applying the nine non-exclusive factors contained in Treas. Reg. § 1.183-2(b). Those factors are:

  1. the manner in which the taxpayer carried on the activity,
  2. the expertise of the taxpayer or his or her advisers,
  3. the time and effort expended by the taxpayer in carrying on the activity,
  4. the expectation that the assets used in the activity may appreciate in value,
  5. the success of the taxpayer in carrying on other similar or dissimilar activities,
  6. the taxpayer’s history of income or loss with respect to the activity,
  7. the amount of occasional profits, if any, which are earned,
  8. the financial status of the taxpayer, and
  9. elements of personal pleasure or recreation.”

If more than one of these factors are applicable to your hobby, you may want to speak to your tax accountant to determine if any tax liability is due.

Also, once the activity has a profitable year, a “presumption period” begins where the IRS presumes that the hobby is actually a business.  Starting with the first profitable year, if the activity is profitable for 3 years within a consecutive 5 year period, the hobby is considered a for-profit business.

Do I have to report income from a hobby?

If you apply all of the IRS test factors, and you determine that your activity is indeed a hobby, you may still owe taxes if that hobby is generating profits.

If you earn profits on your hobby, it must be reported on your personal federal income taxes and is taxed at your personal income tax rate.

Are hobby expenses deductible?

Most hobbies cost money for supplies, fees, dues, or equipment, and as of this writing you are not allowed to deduct those hobby expenses.

For tax years prior to 2018, you are allowed to deduct hobby expenses as an itemized deduction, but you can’t deduct more than the hobby earned.

With the Tax Cuts and Jobs Act of 2017 (TCJA), the hobby expenses deductions are no longer allowed for tax years 2018 through 2025.  If The Tax Cuts and Jobs Act of 2017 is not extended, then the hobby deductions will come back in 2026.

Need Help Determining If Your Hobby Is A Business?

If you need help determining if your hobby is a for-profit business, you may want to give us a call.

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