Things to Remember about Hobby Income and Expenses

Experienced Small Business Accountant -  From scrapbooking to glass blowing, many Americans enjoy hobbies that are also a source of income. A taxpayer must report income on their tax return even if it is made from a hobby. 

However, 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 things to consider:

• Determine if the activity is a business or a hobby. If someone has a business, they operate the business to make a profit. In contrast, people engage in a hobby for sport or recreation, not to make a profit. Taxpayers should consider nine factors (listed below) when determining whether their activity is a business or a hobby, and base their determination on all the facts and circumstances of their activity. For more about ‘not-for-profit’ rules, see Publication 535, Business Expenses. 
• Allowable hobby deductions. Taxpayers can usually deduct ordinary and necessary hobby expenses within certain limits:
• Ordinary expense is common and accepted for the activity.
• Necessary expense is appropriate for the activity. 
• Limits on hobby 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. 
• How to deduct hobby expenses.  Taxpayers must itemize deductions on their tax return to deduct hobby expenses. Expenses may fall into three types of deductions, and special rules apply to each type. See Publication 535 for the rules about how to claim them on Schedule A, Itemized Deductions.

Question - How do you distinguish between a business and a hobby?

Answer

In making the distinction between a hobby or business activity, take into account all facts and circumstances with respect to the activity. No one factor alone is decisive. You must generally consider these factors to establish that an activity is a business engaged in making a profit:

• Whether you carry on the activity in a businesslike manner.
• 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.

You may find more information on this topic in section 1.183-2 (b) of the Federal Tax Regulations.

If you have questions regarding your small business accounting, ABA Tax Accounting is always here. Please do not hesitate to call me, if you have any other questions or need further guidance. Call us for a free consultation at 651-300-4777.