When Does a Hobby Become a Business?

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.

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Originally founded by Ron Clark in 1988, Clark, Campbell, Lancaster & Munson, P.A. has grown steadily as a result of our commitment to recruiting and retaining talented, hard-working, and caring attorneys and staff, to being dedicated to giving back to our community, to providing our clients with professional, timely, and quality legal services, and, generally, to provide excellent, responsive, and result-oriented services to our clients. We strive to keep our clients informed and involved and are proud to have developed long-term relationships with our clients.