Finance Blog

Tax Questions: Is Your Hobby Really a Business?

Written by Eva Rosenberg on November 11, 2013 in Tax  |   No comments

Over the years, I have regularly helped my clients with their tax audits after the IRS determined that their businesses were really hobbies. Filing taxes as a sole proprietor of a business means you can take advantage of tax deductions you may not have access…

tax questions when filing your taxesOver the years, I have regularly helped my clients with their tax audits after the IRS determined that their businesses were really hobbies. Filing taxes as a sole proprietor of a business means you can take advantage of tax deductions you may not have access to if your activity is a hobby, so it’s important to know the difference.

Distinguishing between a hobby and a business for tax purposes

One of the main factors the IRS uses to distinguish between a hobby and a business is the concept of a profit motive. In order for your activity to be considered a business, you must have the intention of turning a profit—either very soon or over time due to the long-term appreciation of your product or idea.

  • The IRS asks other questions when determining whether an activity is a hobby or a business, including:
  • Is the taxpayer dependent on the income from the activity?
  • Are losses due to circumstances beyond the taxpayer’s control, or did they occur upon the start-up of the business?
  • Has the taxpayer tweaked his or her operations to increase profits?
  • Does the taxpayer have the knowledge needed to make the activity a successful business, either alone or with the help of advisors?
  • Has the taxpayer previously made profits from similar activities?
  • Are there some years in which the activity makes a profit?

You can have a business without making an immediate profit

A woman designing and patenting space satellites would not turn a profit in the short term. Her legal and development costs would be high, and it could take a decade or more for her business to become profitable. But, in the end, even one sale could generate a profit of millions of dollars, which is likely the developer’s intent and the reason she is working on the project.

In this example, because there’s an intention to turn a profit after many years, this woman’s hobby would almost certainly be considered a business. Assuming this is the case, she could claim tax deductions for the activities related to her project.

Getting paid doesn’t guarantee your hobby is a business

Based on IRS criteria, certain activities may be considered hobbies even if the hobbyist gets paid. While he or she would still be required to report the income to the IRS, that person would be unable to take advantage of the same tax deductions from which a business owner can benefit.

Take, for example, my old friend Jack, a retired naval sergeant who made beautiful trophy cases. He polished the wood by hand and customized the compartments to fit the recipient’s items of pride. When he made a case for the family of a deceased soldier, he would take special care to create compartments for the flag that had covered the casket as well as any medals of honor, special pictures, and other personal items.

Jack’s trophy cases were highly sought after by veterans from all the armed services, and he made each one with love. He earned a bit of money from each one, but year after year he took took a loss of $5,000 or more on what he was calling a business.

Because Jack went years without making a profit and would not make a profit in the future from appreciation of his wares, he had to change his reporting from calling his work a business to calling it a hobby.

How do you report the financial aspects of a hobby properly?

Hobby-related expenses may only be deducted when you itemize. Report the income generated from your hobby as “other income” on line 21 of Form 1040, and itemize the deductions on Schedule A as “miscellaneous itemized deductions.”

The expenses have two limitations. You can only deduct the expenses from income that is generated from the hobby, and these expenses are reduced by 2 percent of your adjusted gross income (the amount in line 37 on Form 1040).

This means if you make $50,000 per year, you would not be able to deduct your first $1,000 of expenses.

If you don’t itemize, you may find yourself reporting the income and getting no benefit from the expenses. But when you’re doing something you love, who cares if you get tax benefits?

Eva Rosenberg, EA is the publisher of TaxMama.com, where your tax questions are answered. She is the author of several books and ebooks, including Small Business Taxes Made Easy. Eva teaches a tax pro course at IRSExams.com and tax courses you might enjoy at http://www.cpelink.com/teamtaxmama.

No comments yet

Leave a Comment

Name :

Commenting guidelines

We welcome your interest and participation on this forum, but be aware that comments will be published at Equifax's sole discretion. Please don't use this blog to submit questions or concerns about your Equifax credit report or raise customer service issues. Instead, you should contact Equifax directly for all such matters and any attempts to do so in this forum will be promptly re-directed.

Some other factors to consider when commenting:
  1. Registration and privacy. While no registration is required to visit our forum, participants wishing to post a message must register by creating an account. All personal information provided by forum members incident to registration is governed by our Terms of Use and Privacy Policy.
  2. All comments are anonymous. We'll delete your name, e-mail address, and any other identifying information, including details about your investments.
  3. We can't post or respond to every comment - As much as we'd like to, we can't post every comment, nor can we guarantee that we will respond to each individual message. All questions or comments about your Equifax credit report or similar customer service issues should be handled by contacting Equifax directly.
  4. Don't offer specific legal, tax or financial advice. All of the materials on this Site are for information, education, and noncommercial purposes only and this forum is not intended as a means of expressing views or ideas regarding any specific legal, tax, or investment advice. While offering general rules of thumb is both permitted and encouraged, recommending specific ideas or strategies regarding investments, taxes, and related matters is prohibited.
  5. Credit Repair. This blog is not intended as a venue for the discussion or exchange of ideas regarding credit repair or other strategies intended to assist visitors and community members improve or otherwise modify their credit histories, ratings or scores.
  6. Stay on topic. Your comment should be concise and pertain to the specific post in question.
  7. Be respectful of the community. The use of profanity, offensive language, spam, and personal attacks will not be tolerated and egregious or repeat offenders will be banned from future participation. We encourage disagreement and healthy debate, but please refrain from personal attacks on our WordPresss and contributors.
  8. Finally: Participation in this forum may be terminated by Equifax immediately and without notice for failure to comply with any guidelines or Terms of Use. As such, you should familiarize yourself with all pertinent requirements prior to submitting any response through the blog or otherwise. All opinions expressed in this forum are solely those of the individual submitting the comment, and don't necessarily represent the views of Equifax or its management.

Equifax maintains this interactive forum for education and information purposes in order to allow individuals to share their relevant knowledge and opinions with other members and visitors. We encourage you to participate in discussions about personal finance issues and other topics of interest to this community, but please read our commenting guidelines first. Equifax reserves the right to monitor postings to the forum and comments will be published at our discretion. Do you have questions or comments about your Equifax credit report or customer-service issues regarding an Equifax product? If so, please contact Equifax directly. All opinions and information expressed or shared in blog comments are solely those of the person submitting the comments, and don't necessarily represent the views of Equifax or its management.

Tax Archive

Stay Informed Sign up for our FREE Equifax email Newsletter