When you start making money from your hobby, you officially enter a murky gray area for the IRS. Are you a simple hobbyist? Or have you become a …. gulp … small business owner?

Before you panic about what income needs to be reported on which tax forms, take a breath. The IRS provides guidance to point you in the right direction. And if you need a hand, our team at SBS Accounting and Advisors is only an email or phone call away.

A Hobby or a Business? Here is Why it Matters

As you know, the IRS keeps tabs on where your income comes from. It affects how much of your income is taxable and what taxes you pay. That’s why the IRS wants to know whether your activities, such as dog walking, woodworking, arts and crafts, or even flying drones, are a hobby or a business.

Generally, a business requires that you’re trying to make money, and you can back that up with proof – even if you don’t always make a profit. A hobby and a business have different implications for your taxes when it comes time to file, although it’s all part of your personal tax return.

If you do get income from your hobby, you’re still required to report it to the IRS on your Schedule 1 (Form 1040), under “Other income.” If you have allowable deductions from your hobby, you can report them on your Schedule A (Form 1040). If you lose money from your hobby, you can’t take a tax deduction for your losses.

If your hobby has turned into a business, you need to report the income to the IRS on a Schedule C (Form 1040). If you’re self-employed and make more than $400 a year from your hobby-turned-business, you also need to file self-employment taxes on a Schedule SE (Form 1040). If you have business expenses, business asset depreciation or business losses, you’re able to deduct those from your taxable income on your Schedule C (Form 1040).

Which One is Better?

There’s not a better or worse answer to whether your passion project should be a hobby or a business, as it’s a personal choice. There are a few things you might want to weigh when making a strategic decision about your activities.

If it’s a hobby, you don’t need to worry about rigorous bookkeeping or strategies for turning a profit. You might “lose” money, but it might be part of how your hobby works. You might make money, but it’s more of a happy accident. Your work-life balance might feel like less work and more life because your passion project isn’t a job.

If it’s a business, you’ve got to carefully track all the money in and money out. You’ve got more tax forms to fill out for the IRS, but it allows you to lower your taxable income by deducting business expenses and losses. Your goal is to turn a profit, and your livelihood might depend on it. Your work-life balance might feel tipped toward work because your passion is your source of profit.

If your goal is to make a profit, but you take a loss, there is a distinct advantage to the IRS correctly classifying your activities as a business ­– you can deduct those business losses on your tax return. That reduces the total amount of income the IRS can tax for the year.

9 Questions the IRS Considers When Assessing Your Profit Motive

Like a concerned father, the IRS wants to know what your intentions are.

Ultimately, the tax collector wants to know: Are you trying to make money? In the biz, we call this a profit motive. If you have a profit motive, you’re running a business.

Section 183 of the Internal Revenue Code lays out the law around not-for-profit activities, such as hobbies and recreational activities. It includes nine factors that the IRS considers to determine whether you have a profit motive for your activities.

Ask yourself these yes or no questions to get a feel for whether you have a profit motive:

  1. Do you carry on the activity in a businesslike manner?
  2. Does the time and effort you put into the activity indicate that you intend to make it profitable?
  3. Do you depend on the income for your livelihood?
  4. Are your losses due to circumstances beyond your control, or are they normal in the startup phase of your type of business?
  5. Do you change your methods of operation in an attempt to improve profitability?
  6. Do you, or your advisers, have the knowledge needed to carry on the activity as a successful business?
  7. Were you successful in making a profit in similar activities in the past?
  8. Does the activity make a profit in some years?
  9. Can you expect to make a future profit from the appreciation of the assets used in the activity?

There’s no specific number of “yes” answers that qualifies your activity as for-profit. And these aren’t the only factors the IRS might consider when determining whether your activity is  for-profit. The guidance is intentionally vague, giving the IRS wiggle room to make an accurate assessment. But if you’ve answered “yes” to some of the above questions, it’s possible you’ve left the IRS’ realm of not-for-profit activities and entered the for-profit, business zone.

Hobby or Business? SBS can Help You Decide

If all this information has your head spinning like the collection of antique tops you sell for extra cash, we can help.

If your hobby has grown into a for-profit activity, the SBS Accounting & Advisors team can manage activities, such as monthly bookkeeping, quarterly tax filings, and tax-ready financials at the end of the year.

That means more time for you to do what you love – while we do what we love! To talk about your passion project, reach out to us today!