Learn the Difference Between Hobby and Business Before Tax Time

Do you make money from home aside from your regular job? If so, you probably think that a side job is a hobby, not a business. But, if you get it wrong, you could have some pretty messy tax penalties that force you to owe money to Uncle Sam. Before tax time rolls around and it’s time to send in your return, you should know the important difference between hobby and business.

The Important Difference Between Hobby and Business

Hobby or Business?
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Say you sell crafts that you make from your home. You do it in your spare time and sell them to family and friends. You started your crafting as a fun thing to do but quickly realized that people love your crafts and are willing to buy them. Should you classify your craft-making profits as hobby or business profits?

It’s a tricky line that can be a little fuzzy. But, the general rule is that, if you’ve been making a steady profit for the last couple of years from something that started as a hobby, you likely need to start treating it as a business. A hobby, on the other hand, is something that makes you money but you didn’t start it for that purpose. So, your crafting is something you may consider a hobby the first year or two. But, once you successfully make a profit and continue to do so, you shift to a business. To be clear, the IRS says that a hobby should count as a business if it “makes a profit during at least three of the last five tax years.”

How Can It Affect Your Taxes?

Difference between hobby and business
Source: Pixabay

You’ll report hobby income under “Other Income” for your taxes. Business income, on the other hand, counts as taxable business income. You’ll need to report it on Schedule C as Profit or Loss from a Business. Generally, you can deduct certain business expenses from your taxable income, but the same isn’t true for hobby expenses. There are only a select few deductions you can take for your hobby, mostly which relate to the use of your home to carry out your hobby.

So, if you’re shelling out tons of money on craft supplies, you can’t deduct those if you’re running a hobby. When you classify it as a business, though, you can deduct any necessary supplies to create your crafts.

If the IRS determines that your self-proclaimed hobby is actually a business or vice versa, you may be required to pay back money that you weren’t entitled to. If you aren’t clear as to which path to take, talk to a tax expert before filing.