Many people have an interest which they believe can make them some extra cash. So how do you know what to claim on your taxes? Do you have to claim the income from those scarves you knitted and sold at a garage sale? How about those paintings you created that a friend insisted on purchasing?
The answer is simple. The IRS says you must report all income from whatever source derived. Put simply, if you make money from a hobby you must report it. The IRS sees a hobby as something that you do without the purpose of making a profit. Whereas a business is set up for the purpose of turning a profit.
Here are the 9 factors the IRS has developed to help you determine if you have a hobby or a business:
- Whether you carry on the activity in a businesslike manner and maintain complete and accurate books and records.
- 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 change your methods of operation in an attempt to improve profitability.
- 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. Taxpayers can only deduct ordinary and necessary hobby expenses:
Ordinary expense is common and accepted for the activity.
Necessary expense is appropriate for the activity.
Hobby expenses vs Business Expenses. Taxpayers can generally 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.
Business expenses, on the other hand can exceed business income which creates a loss for the tax payer and can assist in lowering tax liability. But there is a fine line between running a business with a loss and simply having an expensive hobby. There can be expensive consequences to categorizing your business losses. If you are self employed, it is best to check with a tax professional to determine if you have a hobby or a business before taking a loss year after year.