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Do you profit from your hobby? Maybe you enjoy making unique craft jewellery and selling your creations on Etsy. Perhaps you’re an amateur painter who just made your first sale. Or maybe you’re furiously writing your first collection of short stories and haven’t successfully published yet.
Whatever your special interest may be, the way you navigate the activity may have an impact on your taxes — and you may even be able to deduct some of your expenses and fees on your tax returns.
How Do You Know If You’re Engaging in a Hobby or Running a Business?
Well, a lot comes down to what country you’re in. In the US for instance, the IRS says it depends on a number of different circumstances — and no one factor is decisive on its own. Rather, the IRS will take a number of different criteria into account to decide whether your activity is actually a business, in addition to whether you personally are engaged in profiting from that activity. Ask yourself the following questions:
- Do you conduct your activity in a businesslike manner?
- How much time and energy are you investing in your activity?
- Do you depend on income earned through your activity?
- Are your losses normal for your type of business? Or are your losses due to circumstances outside of your control?
- Do you have the necessary understanding to conduct your activity as a successful business?
- Have you made a profit from similar activities in the past?
- Have you made a profit from this particular activity? How much profit do you make?
- Can you realistically expect to make a profit from your activity in the future?
If you’ve answered yes to most or all of the above questions, congratulations! You’re probably running a business. That means it’s time to take the necessary steps in filing your taxes.
But What If You’re Still Not Sure?
You may ultimately have what’s called a hobby business. Hobby businesses are usually run from home and are based on semi-recreational activities. Examples include bands for hire, an art studio run from a home office, or a painter who sometimes works on custom cars. A hobby business is usually thought of more as a “labor of love” than as a real startup — but it still counts as a microbusiness and must be handled as such on your taxes.
According to Corporate Tax Network, hobby business income should still be reported on your tax return as other income, no matter how much or how little profit you made. Expenses related to this business are deductible as miscellaneous expenses on schedule A-Itemised deductions. However, if you’re running an unincorporated for-profit business, your income and expenses must be listed on schedule C on your personal tax return. Either way, if you earn a profit of $400 or more, you must pay self-employment taxes.
If you truly want to be profiting from your hobby — and earn the IRS seal of approval in so doing — here is one major piece of advice you should follow.
Keep Consistent and Accurate Records
The IRS will be more likely to consider your hobby a business if you can show a high level of professionalism. For example, no matter how much success you anticipate, it’s always a good idea to start up a separate bank account for your hobby business. Keep accurate records of expenses and income, including saving receipts, invoices and other documents.
Also, Keep Track of Your Losses
If your records are good, then you’ll already have a sense of how much money you’ve made or lost. If you haven’t earned a profit for three out of the past five years, the IRS may be hesitant to classify your activity as a business. However, if you can show these losses were both normal and necessary for conducting your business, you may still be able to claim business status.
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