Many people enjoy various hobbies that are also a source of income. From watercolor painting and pottery to scrapbooking and soapmaking, these activities can be sources for fun and finances. Taxpayers who make money from a hobby must report that income on their tax return, according to the Internal Revenue Service.
If someone has a business, they operate the business to make a profit. In contrast, people engage in a hobby for sport or recreation, not to make a profit. Taxpayers should consider the nine factors below when determining whether their activity is a business or a hobby. They should base their determination on all the facts and circumstances of their activity, according to tips from the IRS.
Also, if a taxpayer receives income for an activity that they don’t carry out to make a profit, the expenses they pay for the activity are miscellaneous itemized deductions and can no longer be deducted. The taxpayer must still report the income they receive on Schedule 1, Form 1040, line 21.
How do you distinguish between a business and a hobby?
In making the distinction between a hobby or business activity, take into account all facts and circumstances with respect to the activity. A hobby activity is done mainly for recreation or pleasure. No one factor alone is decisive. You must generally consider these factors in determining whether an activity is a business engaged in making a profit:
- 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 change your methods of operation in an attempt to improve profitability.
- Whether you or your advisors have the knowledge needed to carry on the activity as a successful business.
- Whether you were successful in making a profit in similar activities in the past.
- Whether the activity makes a profit in some years and how much profit it makes.
- Whether you can expect to make a future profit from the appreciation of the assets used in the activity.
You may find more information on this topic in section 1.183-2 (b) of the Federal Tax Regulations.
Still have questions about hobbies vs. making money from hobbies?
Here’s More Information/Links from the IRS:
- Publication 334, Tax Guide for Small Business
- Publication 525, Taxable and Nontaxable Income
- Publication 529, Miscellaneous Deductions
- Publication 535, Business Expenses
- Publication 17, Your Federal Income Tax
- Schedule C (Form 1040), Profit or Loss from Business (Sole Proprietorship)
- Estimated Taxes