Helpful miscellaneous articles
regarding our retirement plan and planning.
Like you, I review my retirement nestegg and plan from time to
time. Recently, I went though some continued
education for some credentials I maintain and it occurred to me that we all
could use a review about these issues.
So with your help, we will share and post articles and info that may be
helpful and of interest to many of you in this section.
How Much Money Can I Make Before the IRS Considers My Hobby to
be a Taxable Business?
Thu, May 25, 2023 at 8:00 AM CDT
SmartAsset:
IRS hobby vs. business: what it means for taxes
Operating a business on the side can give you
valuable tax deductions as well as extra income. However, the Internal Revenue Service (IRS)
decides if the business is actually a hobby or not. If the IRS says it is, you
could lose the ability to deduct expenses from your income. The primary rule
for determining whether an activity is a business or a hobby is if it produced
a profit in at least three out of five years. Other considerations could come
into play. However, that’s not definitive. We’ll discuss how turning your hobby
into a business can affect your taxes and what the IRS looks for.
Talk to a financial advisor for
help managing your tax liability.
How Turning a Hobby
into a Business Affects Your Taxes
If you can find an activity you enjoy that also
produces a profit, you can have fun while making money. And as an added
benefit, you can get deductions to reduce
your taxable income.
Examples of businesses that potentially are enjoyable as hobbies could include
musical performances, creating craft items for sale and guiding wilderness
backpacking trips. If you charge money for playing music, selling your crafts
or providing guide services, the income could make a business out of what would
otherwise be a hobby.
At tax time, hobbies and businesses get treated very
differently. The money you pay to engage in a business, such as purchasing a
sound system for musical shows or mileage to travel to craft fairs, can be
subtracted from sales revenues to reduce taxable income. If the business
produces a loss, you can even deduct that loss from other income. That includes
salary from working at a job, reducing your overall tax bill.
Making a business out of a hobby isn’t necessarily
all good times, however. For one thing, if the IRS suspects you of trying to
claim business losses from something that is really a hobby, you could be audited. An IRS audit isn’t likely, but
it’s not fun either.
It’s more likely you could simply lose the ability
to deduct losses if your business is ruled to be a hobby. This could increase
your tax bill and remove one of the nice benefits of having a business that is
as enjoyable as a hobby.
If you’re ready to be matched with local advisors
that can help you achieve your financial goals, get started now.
IRS Guidelines for
Identifying Businesses
SmartAsset: IRS hobby vs. business: what it means for taxes
The IRS uses guidelines to determine
whether an activity is a business or a hobby. But these aren’t cast in stone.
An activity doesn’t have to meet all of the guidelines to be ruled a business.
And, even if it does appear to fit the business guidelines, it could still be
categorized as a hobby. Here are the guidelines and some details about their
application:
·
Safe harbor. The surest way to ensure your activity
is seen as a business is to report a profit from it. You don’t have to make a
profit every year, however. If your activity shows black ink at least three out
of five years, it’s presumed to be a business. Again, this isn’t ironclad, but in most cases, it
will suffice. Even if you aren’t profitable that often, your activity may still
pass as a business if it meets one or more of the following guidelines:
·
Profit motive. A hobby is intended for enjoyment and
recreation while a business is intended to make money. You may be able to
convince the IRS you’re doing something for a profit even if
you aren’t actually making money if you:
·
Have made money in the past from similar activities.
·
Are acquiring assets, such as land, that have the
potential for price appreciation.
·
Are managing the activity in the same way as similar
businesses.
·
Advertise or market to get customers.
·
Exert yourself to acquire suppliers and vendors.
·
Work at the activity full-time or at least expend
significant effort.
·
Hire qualified employees to assist you.
·
Keep books and records to assist you in running the
business.
·
Depend on income from the activity to pay
living expenses.
·
Report normal losses that aren’t dissimilar from
similar businesses or are due to uncontrollable circumstances such as fires,
natural disasters or economic downturns.
IRS Guidelines for
Identifying Hobbies
If your activity has certain other characteristics,
it increases the chances the IRS will consider it a hobby. That’s even if it
otherwise might be seen as a business. Here are some of those considerations:
·
Recreational aspects. If your activity is something
usually considered fun, such as visiting beach resorts or trying out new
restaurants, it will be more likely to be labeled a hobby than if it is
something distinctly not fun such as, say, preparing tax returns or pumping out
septic tanks.
·
Personal motives. If the IRS believes
you’re doing the activity because you like it or find it relaxing, it will more
probably be viewed as a hobby.
·
Other sources of income. If other activities, such
as working or investing, are providing you with sufficient income to pay your
bills, it’s less likely the IRS will see your activity as a business.
Reporting Hobby and
Business Income
You’ll usually report income from a business,
whether operated as a sideline or your main source of income, on Schedule C of your Form 1040.
Schedule C has spots for you to record a wide variety of expenses. So you can
accurately report the income from your business.
Income from a hobby that you don’t expect to run
profitably also has to be reported. But it’s much less involved. You’ll do this
on line 8j of Schedule 1 of your regular 1040.
Bottom Line
SmartAsset: IRS hobby vs. business: what it means for taxes
Hobbies turning into a business is a dream a lot of
people have. Being able to enjoy what you do and make money off it is dream
many want to have. It’s even better when it can be deducted to reduce your
taxable income. But you need to make sure that your hobby is in fact a
business. If the IRS finds out you’re using your hobby as a business when it
isn’t, you could be audited. And to prove it’s a business, you need to be
making a profit in 3 out of the last five consecutive years.
Tips for Filing Your Taxes
·
A financial advisor can help you during tax season. SmartAsset’s free tool matches you
with up to three vetted financial advisors who serve your area, and you can
interview your advisor matches at no cost to decide which one is right for you.
If you’re ready to find an advisor who can help you achieve your financial
goals, get started now.
·
If you don’t know whether you’re better off with
the standard deduction versus itemized, you might
want to read up on it and do some math. Educating yourself before the tax
return deadline could help you save a significant amount of
money.
·
SmartAsset has free resources available to help you
during tax season. Check out our income
tax calculator today and get started!
(As with any of these informative articles,
anyone who needs someone to talk to about
this
very subject contact me and I can direct you to a knowledgeable advisor).
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