Is Your Money-Making Hobby a Business? (Hint: It Should Be)

Many people took up new hobbies during the height of the COVID-19 pandemic, and, for many, their new hobbies proved to be profitable. Making money from any endeavor has tax implications, so those who have newfound sources of income must now be sure to report their income on their federal returns.

But, the Internal Revenue Service (IRS) treats different sources of income differently. For example, the tax implications of making money from a hobby and running a small business vary greatly. If you have a money-making hobby, treating it as a business could have significant—and favorable—tax consequences.

Hobby vs. Business: Understanding the Federal Income Tax Implications

The IRS recently published a Fact Sheet discussing the differences in tax treatment for hobbies and small businesses. As the IRS explains, regardless of whether you consider yourself a hobbyist or a business owner, you need to report your income and pay all associated income tax. This is true whether you sell artwork, sell other goods or services, or earn ad revenue from content published online.

But, as the IRS also explains, “If taxpayers aren't trying to make a profit with their hobby, business or investment activity, they can't use a loss from the activity to offset other income.” In other words, if you treat your hobby like a hobby, you get all of the tax disadvantages and none of the tax benefits. But, if you treat your hobby like a business, then you can deduct your expenses—reducing your tax liability or potentially eliminating it entirely.

How do you treat your hobby like a business? And how do you decide if you have done enough to justify deducting your hobby-related expenses? The IRS’ Fact Sheet lists several questions to consider. This includes questions such as:

• Do you maintain books and records where you keep track of your income and expenses?
• Do you do any advertising or promotion?
• Do you devote a significant amount of your personal time and effort to the money-making endeavor?
• Are you pursuing the endeavor full-time or part-time?
• Do you have personal motives for pursuing the endeavor, or “[d]oes the activity lack appeal other than profit”?

No single question is dispositive. For example, even if you engage in your hobby part-time while maintaining a full-time job, it could still qualify as a business for federal income tax purposes. Ultimately, as with all tax-related matters, the key is to make an informed decision. While claiming business expenses can reduce your taxable income, if you do it incorrectly, it can also trigger an IRS audit and tax fraud allegations.

Discuss Your Tax Obligations with Attorney Kevin E. Thorn in Boston

If you have questions about deducting business expenses on your federal income tax returns or any other tax-related legal issue, we invite you to get in touch. To request an appointment with tax attorney Kevin E. Thorn, Managing Partner of Thorn Law Group in Boston, please call 617-692-2989, email ket@thornlawgroup.com or contact us online today.