Hobby Income

To determine if you are really running a business or just enjoying a hobby you must take into account the facts and circumstances of your situation. A hobby for tax purposes is defined as an activity engaged in “for sport or recreation, not to make a profit.” So even if you earn occasional income from doing such an activity, the primary purpose must be something other than a profit motive.

So, from horse breeding to glass blowing, many persons enjoy hobbies that are also income generating. A taxpayer is required to report all income on their tax return even if it is earned from participation is a related hobby activity.

The rules on how to report the income and expenses earned and incurred depends on whether the activity participated in is a hobby or a business. There are special rules and limits for deductions taxpayers can claim for hobbies. In general, you are allowed to deduct ordinary and necessary hobby expenses with certain limitations. An ordinary and necessary hobby expense is one that’s considered common and accepted for the activity. A “necessary” expense is one that’s considered helpful and appropriate for the activity.

Since a hobby is not a business, hobbyists are not entitled to the same tax deductions that businesspeople can claim. As a hobbyist, you can usually deduct your hobby expenses up to the amount of your hobby income. But any expenses that exceed your hobby income are considered personal losses and are not deductible from your other income.

Here are four things to consider:

1)    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 when determining whether their activity is a business or a hobby, and base their determination on all the facts and circumstances of their activity.

·         Whether you carry on the activity in a businesslike manner

·         Whether the time and effort you put into the activity indicate that 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 adjust 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

2)    Allowable hobby deductions. Taxpayers can usually deduct ordinary and necessary hobby expenses within certain limits:

o    Ordinary expense is common and accepted for the activity.

o    Necessary expense is appropriate for the activity.

3)    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.

4)    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 must be taken in the following order:

•       Category 1: Deductions you can take for personal as well as business activities are allowed in full. For individuals, all non-business deductions (such as those for home mortgage interest, taxes, and casualty losses) belong in this category.
•       Category 2: Deductions that don’t result in an adjustment to the basis of property are allowed next, but only to the extent that your gross income from the activity exceeds your deductions under the first category.
•       Category 3: Business deductions that decrease the basis of property are allowed last, but only to the extent that your gross income from the activity exceeds your deductions from the first 2 categories.

User | 5/12/2017