In general, a hobby is an activity that a person pursues because they enjoy it and with no intention of making a profit. People operate a business with the intention of making a profit. Many people engage in hobby activities that turn into a source of income—it can be confusing to determine if that hobby has grown into a business for tax purposes.
To help simplify things, the IRS has established factors taxpayers must consider when determining whether their activity is a business or hobby. Those factors include:
- The taxpayer carries out activity in a businesslike manner and maintains complete and accurate books and records.
- The taxpayer puts time and effort into the activity to show they intend to make it profitable.
- The taxpayer depends on income from the activity for their livelihood.
- The taxpayer has personal motives for carrying out the activity such as general enjoyment or relaxation.
- The taxpayer has enough income from other sources to fund the activity.
- Losses are due to circumstances beyond the taxpayer’s control or are normal for the startup phase of their type of business.
- There is a change to methods of operation to improve profitability.
- Taxpayer and their advisor have the knowledge needed to carry out the activity as a successful business.
- The taxpayer was successful in making a profit in similar activities in the past.
- Activity makes a profit in some years and how much profit it makes.
- The taxpayer can expect to make a future profit from the appreciation of the assets used in the activity.
All factors, facts, and circumstances with respect to the activity must be considered. No one factor is more important than another. If a taxpayer receives income from an activity that is carried on with no intention of making a profit, they must report that income.
Most hobbies are intended to be recreational—they are not usually intended to be for-profit businesses. COVID-19 may have changed that for many people, but the IRS still needs to be convinced. If you follow the guidelines as noted here, there is a better chance the IRS will view the endeavor as a business even if it operates at a loss.
This is just an introduction to a complex topic—there are many provisions and subtleties. Contact R&A for advice on the tax implications of your hobby-turned-business.
About this Author
Laura specializes in income tax return preparation, compliance, and research for individuals and businesses. She also is experienced in preparing compiled and reviewed financial statements, individual and S-Corporation taxation, multi-state taxation, and income tax credits including the R&D credit.