Tax Tips for Money-Making Hobbies
Making some money from your hobby is a fantastic feeling, all until you realize that you need to claim that income on your tax return. Up until 2018, the IRS allowed money-making hobbyists to deduct some of their hobby expenses, but those days are long gone now. These days, you have to contend with the worst situation possible: The money you earn gets taxed, but you don’t get to deduct any expenses. To offset this issue, you may want to type in the best tax relief companies near me on Google search and see if it is worthwhile to transition to running a small business. The truth is that there are not many tax tips for money-making hobbies out there. But there are a few, and we will explore them in this article.
How do you distinguish between a business and a hobby?
Understanding whether your activity counts as a hobby or a small business is imperative. You need to account for all the circumstances and facts that correspond to your activities. Strictly speaking, a hobby activity is not “supposed” to generate profit. In other words, taking up a hobby is something you want to do for fun and not for money. Most hobbies do not have high money-making potential for this very reason. However, some hobbies are more lucrative than others and might account for a sizeable portion of your yearly income.
The problem is that you can’t use any tax breaks for hobbies, as they are not supposed to provide you with a constant source of income. There are practically hundreds of tax reductions for businesses but virtually none for hobbies. When trying to distinguish a hobby from a business, there can be numerous factors at play. And they are all significant.
For example, if you keep accurate books and records for your hobby, the IRS might consider that you are actually running a business. Your time and effort spend is also a large factor in figuring out whether you are partaking in a hobby activity or in a commercial one. However, the key part here is intent. You may be so engrossed in a hobby that you are spending all your time and energy on it. But if you are doing all that because you want to make money, then it is not a hobby but a business.
Factors to consider
The distinction between a hobby and a business comes down to various factors, none of them individually decisive. To figure out whether you should continue your activities as a hobby, you should ask yourself the following questions:
- Are you conducting yourself in a businesslike manner?
- Do you intend to make your hobby profitable?
- Do you depend on the income from the hobby?
- Are you experiencing significant expenditures?
- Were you successful in making money off your hobby in the past?
- Did your hobby make a profit in recent years?
- How much profit did you get from your hobby?
- Can you expect to make a future profit from your hobby?
Depending on the answers, you may find that it is in your best interest to transition from a hobby to running a small business. By doing so, you will be able to take advantage of numerous popular tax deductions, benefit from business-related tax advantages, etc. In most cases, however, the decision will ultimately be made by figuring out how much money is “in play”. If your expenses are not significant and you are earning just a little on the side, then you might as well keep your activities as a hobby. But if your hobby has significant commercial opportunities, you are making yourself a disservice by not turning it into a business.
Tax tips for money-making hobbies
Prior to 2018, you were able to deduct your hobby expenses from your hobby income. This made it so that you could list your hobby expenses on Schedule A, calculate 2% from your AGI (Adjusted Gross Income), subtract the 2% amount from your hobby expenses and arrive at the itemized deduction. Unfortunately, this is no longer possible, not until 2026, at the very least. If you are looking to boost your tax refund amount by deducting hobby expenses, you may need to find another solution. If we look at the facts, there are only a few tax tips for money-making hobbies that we can give you. The first one is to try and negate your expenses.
Tax tips for money-making hobbies #1 – Minimize your expenses
Since you can’t deduct your hobby expenses from your hobby income, you are left with only one choice: Minimize your expenses. Depending on the nature of your hobby, this can range from easy to practically impossible. For example, let’s say that you craft jewelry as a hobby. In that case, you will need to buy all sorts of materials for your crafts. Needless to say, the more time you spend making jewelry, the more expenses you incur. Unfortunately, those expenses will not show on your tax return. You simply cannot protect your income from taxes by deducting hobby expenses. What you can do in this situation, however, is make sure that your costs are minimal. You can have the customers provide you with materials, for example. Or you can adopt a different approach that will lower your overall expenses.
Alternatively, you may simply “pull the trigger” and transition your hobby into a business model.
Tax tips for money-making hobbies #2 – Transition to a business
If your hobby has particularly “nasty” expenses (e.g. raising horses), it might not be in your best interest to be unable to deduct expenses. Transitioning to a business model will provide you with access to numerous tax breaks and allow you to cut your tax bills significantly. Of course, running a business is quite different from spending time with your hobby. But that does not have to mean that you are suddenly expected not to enjoy your hobby anymore. What it does mean, however, is that you need to take a more “serious” approach to it.
Running a business is all about generating profit. However, when transitioning from a hobby, profit can actually be secondary. Yes, you may need to conduct yourself in a businesslike manner from time to time, but most of the time, nothing will change. You may ask, “Why transition in the first place, then?”. The answer is quite simple: Tax benefits.
Businesses, especially small ones, have a large variety of tax breaks available to them. However, taking advantage of those breaks may require a certain “know-how”. The best thing you can do is hire a professional tax consultant before you make the transition. Professional tax agents will explain the details of the transition and the associated tax consequences. It may very well happen that transitioning is not in your best interest. Or it may be the best thing you can do.
Tip#3 – Familiarize yourself with business advantages
First, you must figure out how to report your profits and losses. Most businesses use IRS Schedule C (Form 1040) to report business income and losses. Reporting on Schedule C also allows you to utilize numerous otherwise unavailable deductions.
But there’s another reason you might want to consider the business applications of your hobby. The IRS may decide that your hobby is a business, and the decision will be out of your hands. There are numerous factors in how the IRS makes this decision, including:
- Looking at the things you do to run your hobby – If you are hiring employees for your hobby, knowledgeable employees at that, the IRS may think that you are actually running a business. Another factor that may influence their decision is whether you advertise your hobby. Advertising usually indicates intent to make a profit.
- Earning your livelihood from your hobby – If your hobby is your primary source of income, the IRS may decide that it is not, in fact, a hobby. It is a business.
- Your hobby made a profit for at least three of the past five years – Since a hobby is intrinsically a non-profit-making activity, regular income is always “suspicious”. A year or two where you made a profit off your hobby is fine, but consistent profits point towards a business model.
- You made a profit from a similar business before – Pretty self-explanatory. The IRS will notice if you have conducted a business similar to your current hobby.
If the IRS wishes to re-classify your hobby as a business, you may need to change your activities significantly. However, it is your responsibility to manage your own tax breaks. If your hobby generates significant profits, you should start keeping detailed records. You may have to transition to a business model, want to or not.
Benefits of transitioning a hobby into a business
As you might have noticed, these tax tips for money-making hobbies are mostly about running a business. You simply don’t have any “leverage” otherwise. But a transition to a business does not necessarily mean that you will enjoy your hobby any less. There are significant advantages to making the transition, such as:
- You get to make the rules
- You get to work for yourself
- The market for “hobby” items is huge
Furthermore, by transitioning into a business, you will get to take pride in your work. Seeing how other people appreciate the things you do will boost your self-esteem in a considerable manner. By making your hobby into a business, you can also do what you love every single day.
Your business, your rules
Turning a hobby into a business means that you get to make the rules. You will not need to deal with any managers or bosses; you are both the manager and the boss! This does not mean that you have to take on all the challenges that business operations put in front of you, but you are the one who ultimately makes the big decisions. Furthermore, you have full control of the quality of your product and/or services and complete creative control.
Let’s say that your hobby involves creative painting. By starting a business out of it, you get to enjoy painting as an expressive outlet and make money. Your business does not need to be a 9-5 affair, either. You have the freedom to set your working hours as you wish!
Working for yourself is a massive benefit of a hobby-turned-business
Many people who enjoy their hobbies (and make money off them) are simply not suited for a traditional 9-5 job. It is much better to try and make money by working for yourself than making money for someone else. However, note that running a business usually takes more time than simply partaking in a hobby. You may find yourself to be spending additional time making sure that your business is working as it should. But you get to do that while knowing that you are doing all of that for yourself and not someone else.
As far as tax tips for money-making hobbies go, it is all about how much money your hobby is generating and how much money you can save if you transition to a business model. Minimizing expenses can only take you so far, after all, and you might need to consult a tax professional at some point and learn a thing or two about business taxes. And the perfect place to start looking for both is right here, at Consumer Opinion Guide. Our expert tax advice, alongside the list of all the best tax relief companies, will help you make the most out of the transition!