Posted by KLSM CPA Firm PLLC

Essential Tax Tips for Money Generating Hobbies

Essential Tax Tips for Money Generating Hobbies

Many people have hobbies like playing the piano or bead making simply for fun and do not expect any special monetary compensation from it.   Some hobbies might require a couple of out-of-pocket costs.  The bright side is that you can deduct some portion of your hobby expense on your return. However, to qualify for tax benefits for running a business, Uncle Sam requires you to show some proof.

You will need to determine if your hobby is simply a pursuit of recreation or a money-making venture. It is a realistic goal to earn money doing what you love. One, however, needs to be straightforward about the intention when it comes to claiming exemptions on taxes. 

According to the IRS, the following is a definition of a hobby:

  • An activity you engage in because you love it, not for the profit

  • You expect no profit from the activity.

This does not mean that earning money is taboo. For instance, you might be good with the keyboard, and a friend offered you some money to play on their birthday.

However, a hobby is considered a business if:

  • The hobby generates all or some of your income. For instance, you sell some crochet on an ecommerce store which accounts for over half of your annual income.

  • There are profits and losses from your hobby. For instance, you spent so much on insecticide for your backyard vegetable with the little sale, but people rushed the tomatoes you sold. 


Hobby Income and Expenses 

Starting from 2018, Uncle Sam has stopped taxpayers from deducting hobby expenses as income. All income from your hobby must be claimed, and the expenses cannot reduce it. 

For the tax years before 2018, one could deduct expenses as an itemized deduction subject to 2% of the AGI. In addition, the expense amount claimed cannot be more than the hobby income. This means that there cannot be a loss from the hobby. 

One can only deduct "necessary" and "ordinary expenses."

  • Ordinary expenses are the ones you need to facilitate the hobby like manure and insecticide for a gardener.

  • Necessary expenses are the ones that help you develop the skills required by the hobby, for instance, attending an online farming class.


Standard and itemized Deduction 

In filing the tax return, taxpayers can either go through the standard deduction approach or itemizing route. Deduction for hobby expenses is only possible via the itemizing course. 

For people going through the standard deduction approach:

  • Pick the corresponding standard deduction that corresponds to your case based on the IRS chart. This is a factor of your income and filing status like single, head of household, married, etc. 

  • Fill in the tax amount alongside other required information.


Hobby and Business: A Thin Line

You need detailed records if your hobby is tending towards a business than a leisure and recreational pursuit. As a business owner, you will need Schedule C to report your losses and income, alongside deduction of a series of expenses that hobbyists cannot enjoy. 

When the following conditions apply, Uncle Sam might consider your hobby as a business endeavor:

  • Some of the things you do for the hobby like hiring an expert and advert show you want to make profit.

  • The hobby is your source of livelihood.

  • For the past three years, at least, you have made a profit.

  • Over time, you are hoping that there will be profit from a couple of your business asset 

  • A similar hobby in the past has generated profit for you.

Since it is your responsibility to prove that your hobby business is eligible for some tax breaks, it is vital to have detailed records. They will also be essential should there be an IRS tax audit.


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