I've suggested before that a great way to earn some extra income is to turn your hobby into a business. That said, some of you may prefer to keep your hobby just that -- a hobby (as in non-income producing.) But how the IRS views your hobby -- as a hobby or as a business -- is different than how you may view it.
As you may have guessed, like other things related to the IRS, this can be quite a complicated situation. The Motley Fool tries to explain when your hobby is a hobby, when it's a business, and how you should treat either of these come tax time. Here are their key points:
The IRS has a relatively simple test for determining whether someone is engaged in a hobby or a business. The main issue is whether you are trying to make a profit through your work, which is a goal of businesses but typically not of hobbyists.
However, just because you don't make a profit in a given year, that doesn't mean you didn't intend to make money. The IRS looks at several factors to determine whether you have a profit motive. These include the way in which you operate, how much time and effort you spend on the activity, whether you're financially dependent on the activity for your livelihood, what your level of expertise is, and what actions you take to try to make the activity more profitable. The IRS will also look back to see whether you've made profits in a good number of past years. If you have, you'll more likely be treated as a business for tax purposes. But if you consistently spend more in expenses than you earn in income, the IRS is likely to decide that you don't really have an interest in making money from your labor and will classify what you're doing as a hobby.
Depending on whether your hobby is a business or just a hobby then dictates how you handle it on your taxes. Is it a deduction? If so, what can you deduct? And where? Or did you make money and you owe taxes on it?
I've only had one hobby that was even close to making money (writing magazine articles), and I treated it as a business from the get-go. Why? Because I always intended to earn money doing it and did so from the start. I kept expenses low too, so I always had a profit.
That said, I know many people go from having a hobby for pure fun to developing some income through the years to a point where it's now a business. Just when it goes from being a hobby to a business tax-wise is a tricky question. If you're in this situation, refer to the info above or simply click through and read the full article.
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