Whether you have income from a hobby or a business, it must be reported to the IRS when you file your taxes. However, you can’t deduct expenses or losses from a hobby; you may only claim them for a business (whether it’s your primary source of earnings or a side business). Treating a hobby as a business on your taxes can very possibly trigger an audit.
In the eyes of the IRS, the main difference between a hobby and a business is that the former is done for enjoyment, while the latter is done to earn a profit. But let’s take a closer look at how to determine whether specific income is from a hobby or a business.
Your Recent Profit Record
You have safe harbor protections to call your business a business as long as the activity has been profitable for at least three of the last five consecutive years. This is the simplest way to determine whether you’re dealing with income from a hobby or a business.
If you claim losses more often than this, the IRS will want to classify the activity as a hobby. However, it’s not necessarily this black and white, and there is a more detailed way of evaluating whether you have income from a hobby or a business. And, if you can demonstrate that you meet the criteria, you can make the case that your activity is in fact a business.
Considerations for Whether You Have Income from a Hobby or a Business
The following are important considerations in determining whether your income-earning activity is a hobby or a business. They don’t necessarily all have to apply, but the more that do, the more likely the IRS will agree that your activity is a business.
- Your activity is considered a business if you:
- Carry it out in a businesslike manner (have a business plan, keep receipts, maintain detailed records, etc.)
- Depend on the income to meet living expenses
- Have losses that are due to circumstances beyond your control and/or are typical for a business in your industry
- Make operational changes to counteract losses/improve profitability
- Have the necessary expertise and/or personnel to succeed in the business
- Successfully made a profit with similar activities in the past
- Can reasonably expect to make a profit in the future
