Any income you earn is taxable and must be claimed, even if it does not come from your employer. This includes part-time and temporary work, part-time jobs, and leisure activities that will lead you to a profit. Expenses related to these activities that result in a loss are generally deductible. This is natural, unless the IRS considers your activity a hobby. It`s important to understand the difference between a business and a hobby, as a legitimate business can deduct its expenses and potentially incur a loss if it`s not profitable. But if the IRS considers your activity a hobby, you can`t deduct expenses to get a loss to offset other income. The IRS distinguishes between legitimate businesses and hobby activities for tax purposes. The agency considers a business as a for-profit entity and a hobby activity as a non-profit activity. According to the IRS, a legitimate business has “income or profit” as its primary purpose and is involved in a for-profit or income-oriented activity “with continuity and regularity.” A hobby is any activity that a person pursues because they love them and with no intention of making a profit. People run a business with the intention of making a profit. Many people engage in hobby activities that become a source of income. However, determining whether this hobby has become a business can be confusing. Although you are subject to self-employment tax, there is still an important advantage to the fact that you can deduct eligible business expenses if your activity is classified as a business and hobby.
However, it`s important to make sure you`re legitimizing your business in the eyes of the IRS. Part 3 of this series focuses on good business practices that are not only important for any business, but also help you classify your business as a legitimate business for tax purposes. How does this affect amateurs? Once the TCJA is signed, hobby-related expenses or losses that a taxpayer may claim to reduce their hobby income in previous taxation years are no longer allowed. This applies to tax returns filed between the 2018 and 2025 tax years. The downside of classifying an activity as a hobby is that you can`t deduct expenses related to the hobby. Due to a change under the tax reform (elimination of various individual deductions under the Tax Cuts and Jobs Act (TCJA)) from 2018 to 2025, unless the AYAC is otherwise extended, you are no longer eligible for a hobby expense deduction. This means that you cannot deduct hobby expenses under the TCJA, but you will still have to report 100% of all income from the hobby activity as income and pay income taxes. And since you can`t use hobby expenses to reduce your hobby income, you can`t use a loss from hobby sales to reduce other income. This can be important if you make money from other activities that you wanted to make up for with losses. The owner of a for-profit business can fully deduct ordinary and necessary business expenses. If the business incurs a loss, it can be used to offset other income on the owner`s personal tax return.
In the past, hobbyists could deduct expenses up to the amount of their hobby income, but no more. Please check back next week for our final article in the series, which looks at good business practices for running and running an online business. And if you`d like to learn more about the differences between a hobby and a business for tax purposes, and how it might affect your tax filing needs, or how to start or organize a business unit, please contact the author of this article, attorney Britany E. Morrison at O`Neil, Cannon, Hollman, DeJong & Laing S.C. to discuss how we can help you. In addition, the IRS proposes a Safe Harbor rule that assumes an activity is a business, not a hobby, if it has made a profit in at least three of the last five years. If you answered yes to some of these questions or if you complied with the Safe Harbour rule, you probably have a business. However, if you answered no to most of these questions and don`t comply with the Safe Harbor rule, the IRS will likely classify your job as a hobby. The tax implications are explained below.
There is no definitive timeline for this type of tax audit, and the IRS only checks if it has any concerns about the activity (legitimate business vs. hobby). Some audit triggers may be: Adjusted gross income (AGI) is the gross income of a tax return minus the adjustment.