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Business or hobby: Here's how the IRS decides

From arts and crafts to sailing, woodcarving or horse breeding, we all have hobbies in which we enjoy. Some of these hobbies you can use to make a little extra money on the side, in addition to finding pleasure in the activity itself. Sometimes these hobbies can blossom into a business, but the IRS has specific rules in determining whether or not what you do is ultimately for profit or just for fun.

When a hobby makes you money

Like a business, you can write off some expenses from a money-making hobby, but the amount differs when there's no profit motive. For example, say you have a woodworking hobby and like to attend craft fairs where you view the work of others and occasionally sell your own. In one year, you spend $3,000 in supplies, equipment and gas in getting to and from shows. In that same year, you made $1,000 back in selling your work. How much can you write off? 

In this situation, you could write off $1,000. According to IRS rules, you can write off expenses that are equal to the amount of your gross income in a hobby, but expenses beyond your hobby income cannot be deducted. Why is this the case?

Profit vs. recreation

Business owners incur a significant amount in expenses annually. While your hobby might be expensive too, the IRS recognizes the difference in motives. When a person starts a business, they are doing it to make money, but in a hobby, you are doing it for leisure. Capping the number of deductions in hobby expenses prevents frivolous expenses and maintains the integrity of our tax needs and infrastructure.

What if I want to turn my business into a hobby?

Sometimes people realize that they have the ability to turn their hobby into a full-time business. If you think you can do this for yourself, it is essential to take steps to formalize your operations from a hobby to a business.

The IRS will look for specific "business" elements when determining whether or not you have a business or hobby. These criteria could include:

  • Recordkeeping of income and expenses
  • Your credentials and experience in the line of work
  • Your financial status and other sources of income

Hobby entrepreneurs can also take steps in incorporating a business by establishing an LLC or other formal structures with the help of Goldburd McCone LLP. Ultimately, when considering the tax implications of your hobby, it is important to remember that fun comes first.

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