Is It a Hobby or a Business?
We often dabble in various activities during our downtime. Some people enjoy fishing, others enjoy photography. The range of enjoyable activities can range from person to person. Often, our hobby can turn into a side hustle, which can cause you to wonder how to handle the income on your taxes.
What is a hobby?
If you receive income from a hobby (not a business, or for-profit activity), it is taxable. Such income can be reported on your Form 1040, Schedule 1 - "Additional Income and Adjustments to Income" on Line 8 "Other Income". Any losses realized from a hobby are considered personal losses and thus not deductible. On the other hand, losses from business, or for-profit activities are generally fully deductible. For this reason, the IRS will look closely at an activity you claim to be a business, if that activity continuously shows losses.
What is a business?
If an activity you are engaged in shows a profit for a minimum of three out of the last five years, then this activity will be considered to be a business by the IRS.
Caution: If the activity is related to the breeding, racing, showing, or training of horses, you must show a profit in two out of the last seven years to be presumed to be in a business activity.
Is the "business test" automatic?
No. The fact that you make a profit on an activity for the minimum three out of five years (or two out of seven for horse-related activities) does not automatically mean the IRS will treat the activity as a business. In some cases, the IRS may claim the activity is still a hobby. In making a determination between profit and business activity designation, the IRS will look at questions and issues such as the following:
Do you run the activity like a business (keeping records, setting up a business bank account, and the like)?
How much time do you spend on the activity?
How much personal pleasure or recreation does the activity provide you?
Do you expect that the assets related to the activity will increase in value?
What is your overall financial status? For example, if you have income, especially a lot of income, from other sources, it may lead the IRS to the assumption that this activity is a hobby.
Have you made a profit before in similar activities?
What degree of expertise related to the activity do you have?
Do you hire experts in the field to advise you in the activity?
Is it normal to have losses for a number of years in the start-up phase of the type of activity/business you are engaged in?
Other to note
Note: For 2018 to 2025, the deduction for miscellaneous itemized deductions subject to the 2-percent floor, including hobby expenses, has been suspended, and cannot be claimed as an itemized deduction on Schedule A of IRS Form 1040. You will generally not be able to deduct your expenses from a hobby.
Always check with your CPA or tax professional on your personal tax situation.