If you derive income from any activity where you are not an employee, from occasional dog sitting to playing guitar for tips at your local coffee shop, then the IRS requires you to classify the activity as either a hobby or a business on your tax returns. Importantly, this decision must be based on IRS rules governing what constitutes a business, not on how you personally view the activity.
If your project is reported as a business, you may be able to deduct almost all expenses related to the project, even if those expenses result in a net loss some years. However, your net business income (profit) will be subject to self-employment tax. Meanwhile, hobby income is exempt from self-employment tax, but the Tax Cuts and Jobs Act (TCJA) eliminated most deductions for hobby-related expenses. Generally, if an endeavor involves very little expense and accounts for a small percentage of your annual income, it is probably best to report it as a hobby. In many other cases, you may be surprised to learn that you can, or even must, call your favorite hobby a business—and that doing so has significant tax advantages (because business expenses are fully deductible but hobby expenses are only deductible up to the amount of income you earned on the hobby).
IRS guidelines say that “The feature of a business is that pople do it to make a profit. People engage in a hobby for sport or recreation, not to make a profit.” IRS says to consider the following nine activities to determine whether an activity is a hobby or a business.
1) Whether you carry on the activity in a businesslike manner and maintain complete and accurate books and records.
2) Whether the time and effort you put into the activity indicate you intend to make it profitable.
3) Whether you depend on income from the activity for your livelihood.
4) Whether your losses are due to circumstances beyond your control (or are normal in the startup phase of your type of business).
5) Whether you change your methods of operation in an attempt to improve profitability.
6) Whether you or your advisors have the knowledge neeeded to carry on the activity as a successful business.
7) Whether you were successful in making a profit in similar activities in the past.
8) Whether the activity makes a profit in some years and how much profit it makes.
9) Whether you can expect to make a future profit from the appreciation of the assets used in the activity.
(note: These 9 steps are from: https://www.irs.gov/faqs/small-business-self-employed-other-business/income-expenses/income-expenses)
The rule of thumb is your business can be considered a business rather than a hobby if you make a profit for at least 3 out of every 5 years of operation. If the profit was just a few dollars that is good enough for the IRS to call it a business.
My practice is in Severn, MD.
*I specialize in the following services for both businesses and individuals:
*Tax Planning &Tax Preparation for business owners and individuals.
*IRS Representation & Tax Resolution for business owners & individuals who have back tax debt.
*Real Estate Investor Accounting: I specialize in helping real estate investors improve their bottom line.
Contact me for any help needed at:
Lisa D Church, CPA, EA, NTPI Fellow, MBA
7865 Clark Station Rd
Severn, MD 21144