October 7, 2015

32936586_sMillions of people across the country engage in hobbies in order to relax from the hustle and bustle of everyday life. For many people, hobbies also offer an additional source of income. The question is: Do hobbyists need to worry about paying taxes for their activities?

The answer is yes. According to the IRS, all money earned from a hobby must be reported on your tax return as income – whether it may be from breeding animals, making arts and crafts, or collecting coins.

Hobby vs. Business

If you are wondering whether or not you need to pay taxes for a particular activity, the first thing you need to do is identify whether this income is earned from a hobby or a business. Did you complete a project for pleasure or in order to make a living?

If the activity or project is something you pursue for fun or for pleasure without intending to generate profit, then it is considered a hobby. A hobby is something you would still continue to do even if you lost money because it is something you enjoy doing.

In order to determine whether your activities are engaged in for profit, the IRS may use the profit test, which reveals whether you earned money on the activity in three out of five years.

The IRS may also take a number of factors into consideration:

  • Whether the activity is carried out in a businesslike manner.
  • If you are dependent on income from the activity.
  • How much time and effort is put into the activity.
  • If you changed methods of operation to improve profitability.
  • If any losses are due to conditions beyond your control or if they are normal for a business in its startup phase.
  • Your background and knowledge in running a business.
  • If you have made a profit from similar activities in the past.
  • Whether the activity is profitable in a few years, and how much.
  • Whether the appreciation of assets used in the activity can make a future profit.

Deducting Losses

In terms of taxes, the primary difference between a business and a hobby is the ability to deduct losses from its activities. For a business, you may be able to deduct the cost of your equipment, educational fees, supplies, and other expenses on your tax return – even if your expenses are more than your business income – and then you may possibly qualify for a refund.

For a hobby, on the other hand, you may only be allowed to deduct up to the total amount of income earned from the hobby. Before these can be deducted however, miscellaneous expenses – including hobby expenses – that are itemized on Schedule A must be greater than two percent of the adjusted gross income.

You must be able to itemize the expenditures in order to claim any expenses for your hobby. It is therefore essential to keep detailed records of all your transactions.

If you make money from your hobby regularly, it may be to your tax advantage to turn this sideline into a business.


Categories: Blog, Tax Tips, Taxpayers' Rights