Individuals who make money from a hobby must report that income on their tax returns. However, the rules for how to report the income and expenses depend on whether the activity is a hobby or a business. If someone has a business, they operate the business to make a profit. People who engage in a hobby, do not. There are special rules and limits for deductions you can claim for hobbies.
You can only deduct ordinary and necessary hobby expenses:
- Ordinary expense is common and accepted for the activity.
- Necessary expense is appropriate for the activity.
You can generally only deduct hobby expenses up to the amount of hobby income. If hobby expenses are more than its income, you will have generated a loss. However, a hobby loss cannot be deducted from other income and you would have reported these expenses only if you itemized your deductions.
The Tax Cuts and Job Acts (TCJA) changed how hobby expenses are reported. Hobby expenses are considered miscellaneous itemized deductions and can no longer be deducted, since miscellaneous itemized deductions have been eliminated. You must still report the income received as other income on schedule 1 on your 1040 tax return.
How do you know if you are operating a hobby or business? You will need to take into account all the facts and circumstances with respect to the activity. A hobby activity is done mainly for recreation or pleasure.
Consider the following factors in determining whether an activity is a business engaged in making a profit:
- Whether you carry on the activity in a businesslike manner and maintain complete and accurate books and records.
- Whether the time and effort you put into the activity indicate 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 change your methods of operation in an attempt to improve profitability.
- Whether you or your advisers 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. (1)
A hobby is a wonderful thing. It brings enjoyment, relaxes, and refreshes. Don’t let that be tarnished by taxes and don’t let a business get into financial trouble because of being unprepared for taxes. Let’s talk and make sure you are set up for success! Please see my website and call my office at 407-559-1047.
(1) Code section 1.183-2 (b)