Hobbies can easily become a source of side income. Commonly known hobbies that make money include crafts such as selling your handmade embroidery, paintings, pottery, and even soap. Other hobbies could be pet sitting, growing and selling food, blogging, and even selling items online! While we usually think of income earning hobbies as something you do for fun, you still need to report the income on your tax return.
Luckily, there are special rules to help even out the extra income.
You can deduct hobby expenses! The money you put into the supplies for your hobby can be deducted as long as they are ordinary and/or necessary. An ordinary expense means the expense is common and accepted for the hobby. A necessary expense means it’s appropriate for the activity.
For instance, if your hobby is to create (and then sell) paintings, you may be able to deduct the cost of the canvas, brushes, and paint. You must have those pieces of equipment to paint. But if you take a trip to an island to get inspired and recreate the ocean waves in your artwork, you can’t expense the trip, since it is neither ordinary or necessary.
There are a few other restrictions regarding hobby deductions. First, you may only deduct hobby expenses up to the amount of hobby income. Second, you can’t take a loss from hobby expenses. If your hobby generated more expenses than income, you technically have a loss, but since the activity is not classified as a business, you are not allowed to deduct that loss from your other income. Third, if you want to deduct your hobby expenses, you have to itemize.
Hobby vs. Business
If you have a profitable hobby, sometimes it makes sense to turn that hobby into a business for tax purposes. The key word here is profitable hobby. You should not take something you enjoy doing and create a business simply for the tax benefits. In fact, there could be major penalties for doing so.
To determine if your activity should remain a hobby or become a business, there are nine factors to consider. You should be able to answer “yes” to these questions if you want your activity to be classified as a business.
- Do you carry on the activity in a businesslike manner and maintain complete and accurate books and records?
- Does the time/effort you put into the activity indicate you intend to make it profitable?
- Do you depend on the income from this activity for your livelihood?
- Are your activity losses due to the normal startup phase of a business?
- Are you willing to change your method of operation to become more profitable?
- Do you have the expertise (or have you hired an advisor) to carry on the activity as a successful business?
- Have you been successful in making a profit at a similar activity in the past?
- Has your activity made a profit? How much?
- Do you expect to make a future profit from the appreciation of assets used in the activity?
If you have a hobby that may actually be a business, it would be beneficial to discuss it with your hb&k advisor. In addition to giving you tax advice, we can give you business advice to help you create a strategic plan and grow.