Do you have a hobby you’re so passionate about that you’ve started to build a business around it, such as making arts & crafts and selling it at street fairs? Unless you devote much effort into it and consistently turn a profit, the IRS may determine your venture as a hobby and not a business.
Hobby or Business?
When determining hobby or business operations, the IRS primarily looks at if the business is actively engaged in making a profit. They generally look to see if the business made profit in consecutive years otherwise it may fall under the category of a hobby. Here are some additional factors to consider when determining if your business is a hobby:
- Is the business carried out in a business-like manner with complete and accurate books & records?
- How much time and effort is put into the business to make it profitable?
- Does your livelihood depend on income from this business activity?
- Is this business activity profitable in some years?
Hobby Deductions
While being considered a hobby activity disallows access to several small business expense deductions you would see on the Schedule C, there are some allowable hobby deductions. For example, Ordinary and necessary expenses related to your hobby venture are still available. However, those deductions are all limited up to the income of your hobby venture. Deductible losses beyond that cannot be claimed. For example:
Deb runs her artisan artichoke dip business on the side. She runs it only on weekends due to her regular job during the week. It doesn’t do too well in its first few years and she decides to close it. It barely earns $1500 in income, but cost her $2500 in expenses to start up and operate. Deb can only claim up to $1500 in allowable hobby deduction losses.
Claiming Hobby Losses
Hobby losses are claimed on Schedule A, just like other itemized deductions that you would claim for your individual tax filing. By having enough itemized deductions such as hobby losses, you can potentially lower your taxable income.
While starting up a hobby-based business is often a passion project, elevating it into a full-blown business operation can take time and a proper support team. Good accounting is necessary for any growing business. Look no further for that. MiklosCPA is a California-based CPA firm that supports many small and emerging businesses with their tax and accounting needs. Consider giving us a call, and follow us on our social media for more upcoming “good-to-know” pieces.