By: Clark, Campbell, Lancaster & Munson, P.A.
Do you have a hobby that has become profitable on eBay, Etsy, or social media? If so, the IRS may consider your hobby a business, and certain income tax consequences may result.
Q: What is the difference between a hobby and a business?
The IRS has provided the following nine factors a taxpayer should consider:
- Is the activity carried on in a businesslike manner?
- Does the time and effort put into the activity indicate an intent to make a profit?
- Does the taxpayer depend on the income from the activity?
- Are the losses from the activity beyond the taxpayer’s control?
- Has the taxpayer made changes to improve profitability?
- Does the taxpayer have the knowledge to carry the activity as a successful business?
- Has the taxpayer made a profit from similar activities in the past?
- Does the activity make a profit in some years?
- Does the taxpayer expect to make a profit in the future due to an appreciation of the assets used in the activity?
Overall, the key issue is whether a taxpayer treats the activity as a business and whether the taxpayer has an expectation of profit from the activity.
Q: If my hobby produces income, is it considered a business?
Not necessarily. A hobby can produce income even though the taxpayer does not have an expectation to make a profit. For example, a taxpayer enjoys painting swans on the weekends and frequently posts pictures of her paintings on social media. Taxpayer’s friend offers to buy a painting for $100. Taxpayer usually does not sell her paintings, but decides to take the $100. Taxpayer likely has a hobby because the taxpayer does not have an expectation to make a profit when she paints. However, if the taxpayer were to advertise her paintings for sale on social media, then the taxpayer may have a business.
Q: What are the tax consequences of a hobby and a business?
Regardless of whether the taxpayer has a hobby or a business, the taxpayer must report any income received. Therefore, in our example above, the taxpayer should report the $100 as income. A taxpayer may deduct the ordinary and necessary expenses from a hobby or business, but a taxpayer may not deduct a loss from a hobby. In our example above, assume the taxpayer spent $150 on painting supplies. If the taxpayer has a hobby, then the taxpayer may only deduct up to $100 on painting supplies as ordinary and necessary expenses because she received only $100 of income, and may not deduct a loss of $50. If the taxpayer has a business, then the taxpayer may deduct the full $150, which will result in a $50 loss.
Generally, the IRS is reluctant to find that a hobby qualifies as a business since a business may deduct losses. However, if a taxpayer treats the hobby as a business, such as maintaining a separate bank account and budget, forming a business plan, and keeping books and records, then it is more likely the IRS will find that the hobby qualifies as a business.