All of us have hobbies and some of us can even generate income from a hobby. In recent times with the popularity of e commerce, selling a product, like handmade jewelries is within the reach of everyone. Even though you might engage in such hobbies not with an intention to run a business, but to generate some side income, remember you have to report your hobby income on your income tax return.
Hobbies Are Not Tax Efficient
Hobbies are fun, but do cost money and they are not tax efficient. Why?
- You cannot claim a loss
- You cannot claim the operating expenses. But you can claim the cost of goods sold, which is allowed to be deducted from the hobby income.
- You have to report gross hobby income less cost of goods sold
You might be able to use the operating expenses after 2025, but generally only as a miscellaneous deduction subject to 2% adjusted gross income limitation and only if you have enough itemized deductions to be able to itemize on schedule A of your personal tax return.
For these reasons you have to understand if you can report your hobby as a business and claim ALL your expenses as a reduction to income.
When Can You Report Your Hobby As a Business?
To consider a hobby as a business you need to answer questions like:
- Do you maintain complete income and expense records of your hobby just like a business would?
- Do you make a profit or intend to make changes to your method of operation so as to make a profit?
- Are you trained or do you have the knowledge necessary to carry out the activity as a business?
- Do you depend on this activity to generate income for your livelihood?
- Do you put necessary time and effort to make the activity profitable?
If you find yourself answering YES to these questions then you might qualify to report your activity on schedule C of your personal income tax return, reporting this way only the net income (after ALL expenses). One other tax advantage of having a business instead of a hobby is that you can use the qualified income deduction (generally 20% of your business net income, with some limitations).
To see all the 9 factors the IRS looks at when determining if an activity is a hobby or a business, click here.
On the other hand, the disadvantage of reporting your activity as a business is that you have to pay self-employment tax (approximately 15.3%) on the net income, while the hobby income is not subject to self-employment tax.
If you need help on how to report your hobby or business activity, click here to schedule an appointment.
This material is for informational purposes only. It does not constitute tax, legal or accounting advice.