Earning side income: Is it a hobby or a business?

Earning side income: Is it a hobby or a business?

I get asked this question fairly frequently: What do I need to do about extra money I’m making on something I’m doing on the side? There is a lot of information out there regarding hobby tax and how the IRS defines a hobby—not all accurate information, either. This most often comes up when people are involved in direct sales or have a craft or specialty food they make and sell at craft and vendor shows.

Whether it’s something they’ve been doing for years or something they just started to make extra money, taxpayers must report income earned from hobbies in 2020 on next year’s tax return.

What the difference between a hobby and a business? A business operates to make a profit. People engage in a hobby for sport or recreation, not to make a profit.

Here are nine things taxpayers must consider when determining if an activity is a hobby or a business:

1. Whether the activity is carried out in a businesslike manner and the taxpayer maintains complete and accurate books and records.
2. Whether the time and effort the taxpayer puts into the activity show they intend to make it profitable.
3. Whether they depend on income from the activity for their livelihood.
4. Whether any losses are due to circumstances beyond the taxpayer’s control or are normal for the startup phase of their type of business.
5. Whether they change methods of operation to improve profitability.
6. Whether the taxpayer and their advisors have the knowledge needed to carry out the activity as a successful business.
7. Whether the taxpayer was 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 the taxpayers can expect to make a future profit from the appreciation of the assets used in the activity.

Ask us if you have questions about how and what you should report.

More Information:
Publication 17, Your Federal Income Tax
Publication 525, Taxable and Nontaxable Income
Publication 535, Business Expenses
Publication 334, Tax Guide for Small Business, For Individuals Who Use Schedule C

 

Posting Date: September 8, 2020