Determining Whether Your Hobby is a Business

Millions of people
enjoy hobbies that are also a source of income. From catering to cupcake
baking, crafting homemade jewelry to glass blowing — no matter what a person’s
passion, the Internal Revenue Service offers some tips on hobbies.

Taxpayers must
report on their tax return the income earned from hobbies. The rules for how to
report the income and expenses depend on whether the activity is a hobby or a
business.

There are special
rules and limits for deductions taxpayers can claim for hobbies. Here are five
tax tips to consider:

Is it a Business or a
Hobby?

A key feature of a
business is that people do it to make a profit. People engage in a hobby for
sport or recreation, not to make a profit.

Consider the
following nine factors as set forth by the IRS when determining whether an
activity is a hobby. Make sure to base the determination on all the facts and circumstances.

• Whether you carry on the activity in a businesslike manner and
  maintain complete and accurate books and records.

• Whether you have personal motives in carrying on the activity.

• Whether the time and effort you put into the activity indicate you
  intend to make it profitable.

• Whether you depend on income from the activity for your livelihood.

• Whether your losses are due to circumstances beyond your control
  (or are normal in the startup phase of your type of business).

• Whether you or your advisors have the knowledge needed to carry on
  the activity as a successful business.

• Whether you were successful in making a profit in similar
  activities in the past.

• Whether the activity makes a profit in some years and how much
  profit it makes.

• Whether you can expect to make a future profit from the
  appreciation of the assets used in the activity. 

Allowable Hobby
Deductions

Within certain
limits, taxpayers can usually deduct ordinary and necessary hobby expenses

An ordinary expense
is one that is common and accepted for the activity. A necessary expense is one
that is appropriate for the activity.

Limits on Hobby
Expenses

Generally,
taxpayers can only deduct hobby expenses up to the amount of hobby income. If
hobby expenses are more than its income, taxpayers have a loss from the
activity. However, a hobby loss can’t be deducted from other income.

How to Deduct Hobby
Expenses

Taxpayers must
itemize deductions on their tax returns to deduct hobby expenses. Expenses may
fall into three types of deductions, and special rules apply to each type.