If you’ve been making some money off of your hobby- congratulations! It’s every hobbyist’s dream to be making money off of doing what they love. However, it’s important to know at what point a hobby is considered a business for a variety of reasons.
While there are no set criteria for distinguishing a hobby from a business in the eyes of the IRS, there are a few considerations that go into making their decision, like activity, profit, and business validity. If your hobby becomes your main source of income, then it's a business and needs to be declared.
If you’re interested in figuring out when a hobby becomes a legal business, keep reading for the best information out there on the subject.
If you’re new to business, you may be wondering why it’s even important to know if your hobby is considered a legal business. The answer is the IRS or Internal Revenue Service.
Your eligibility for certain tax actions is determined by the legal status of your hobby or business. There are certain benefits for hobbies that are considered legal businesses by the IRS that can make your life as a hobbyist or business owner easier - let’s take a look at the most significant ones.
For instance, if your hobby is considered a legal business, you can declare business losses if your expenses exceed your profit for the year.
This sounds like a bad thing, but it allows you to use the total loss towards tax refunds in the future.
This one of the most major motivators for hobbyists to try and legitimize their hobby as a business.
** Please note, we are not accountants. You should always seek the advice of a professional registered accountant. This article is for information only **
You’ll also be able to deduct business expenses if your hobby is considered a business. This means you will be able to remove certain expenses from your income before it is taxed, meaning your business suffers from less tax liability.
" Generally, the IRS classifies your business as a hobby, it won't allow you to deduct any expenses or take any loss for it on your tax return". ( Source )
If your hobby is considered a hobby, you’re only able to deduct hobby expenses up to the total amount you earn.
Now we know the benefits of our hobby being considered a business - deducting business expenses and declaring business losses. Let’s take a look at what determines whether your hobby is a business or not in the eyes of the IRS.
As previously mentioned, the IRS doesn’t have a set amount of requirements to distinguish your hobby from a business.
There are a few factors they will be monitoring though that will influence their decision in classifying your hobby. These include:
One of the most important factors the IRS considers, if not the most important factor, is whether or not you are actively trying to make a profit off your products or content.
It can be difficult to prove this if you’re a start-up business and aren't making a lot of money at the start, but sadly the best way to influence their decision is to, well, make a profit.
If you can prove that you’ve made a profit for the first several years your company has operated, it is unlikely that the IRS will declare your business a hobby.
This doesn’t have to be a crazy amount of cash per year - even proving you’ve made a few dollars each year counts.
Of course, if the IRS finds out your business is illegitimate in any way, you will not be considered a legal business.
Deducting business expenses and declaring business losses from your tax forms before you’re considered an official business is a great way to stay on hobby status and get into some legal trouble, too.
Making sure that you’re following the proper tax procedures according to the classification of your hobby is essential. But what is the best way to prove to the IRS that you’re a valid, profit-making business?
Let's dive into how you can gain or keep your business status by making records of expenses and profits and playing by the rules.
When it comes to proving your business legitimacy to the IRS, diligence is key. You can’t simply make a few dollars in profit and do nothing else - you have to show on paper that your business is legitimate in a few ways.
First, you’ll want to keep track of your expenses, profit - everything. Learn to get familiar with accounting books and log everything you spend and gain in those books.
You can use these to show the IRS that you’ve been diligently keeping track of your expenses and gains like a real business.
Keep as many of these types of records as possible and organize them so that they’re easy to retrieve at any moment. This way, you'll have access to all the information you need if the IRS asks for it.
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Try promotional marketing for your hobby, too! Many businesses engage in promotions on social media, television, and physical advertisements to increase their range of consumers.
This is another great way to prove to the IRS that you’re dedicated to legitimizing and growing your business.
Finally, one of the best ways to make sure the IRS knows you’re dedicated to becoming a legitimate business is to make sure everything you do is legal and done according to the proper procedures.
Don’t try to skimp your way around anything - it will be horribly difficult to legitimize your hobby as a business if the IRS is turned onto anything illegal you’ve done.
Legitimizing your hobby by turning it into a legal business is a great option for entrepreneurial-minded hobbyists looking to turn their hobby into a real money-maker.
Show that you’re legitimate by making a consistent annual profit and playing by the rules and prove this with your accounting books and records.
And if you’re making money from your hobby but don’t want to turn it into a business - that’s fine too! Either way, you’ll get some cash from doing what you love. Good luck!