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Hobby Income: Five Things You Need to Know

Hobby Income: Five Things You Need to Know
Ines Zemelman, EA
13-Dec-17

There are thousands of Americans who earn income from their hobbies. Hobby or not - It is important to remember that this income must be reported on a taxpayer’s tax return, regardless of whether it is from a traditional job or a favorite pastime.

Hobby, or Business?  It depends. A business is operated with the intention to make profits. Hobbies are for recreation, not to get profit. The IRS has a list of nine factors that must be considered in the context of the entire set of circumstances when making the determination.

Hobby vs Business Checklist

Do you carry on the activity in a businesslike manner?

 

Yes ๐‡                     No  ๐‡

Does the time & effort you put into the activity indicate that you intend to make it profitable?

 

Yes ๐‡                     No   ๐‡

Do you depend on income from the activity for your livelihood?

 

 

Yes ๐‡                     No   ๐‡

Are losses in the activity beyond your control, or normal in the startup phase of a business?

 

Yes ๐‡                     No   ๐‡

Do you change your operation to improve profitability?

 

Yes ๐‡                     No   ๐‡

Do you or your advisors have the knowledge needed to carry on as a successful business?

 

 

Yes ๐‡                     No   ๐‡

Have you made a profit in similar activities in the past?

 

Yes ๐‡                     No   ๐‡

Has the activity made a profit in some years  & was it substantial?

 

Yes ๐‡                     No   ๐‡

Can you anticipate to make a profit from the price appreciation from assets used in the activity?

 

Yes ๐‡                     No   ๐‡


It is important to note that many limits and rules apply to deductions for hobbies, but below are five items to keep in mind.

Your background & prior experience matters

One of the primary factors separating a business that loses money from a hobby is whether you had a success with such activity in the past and whether your background proves the potential to make profit in the future.

For example - a math teacher decides to make extra money as a florist and keeps losing money year to year. Despite best efforts, the taxpayer would have little chance to get those losses approved as business losses. This is a hobby, therefore loss cannot be taken.

Hobby deductions & expense limitations

It is important to note that many limits and rules apply to deductions for hobbies. Hobby losses cannot reduce your tax due on other income

  • Deductions for hobbies. Common and necessary hobby expenses can be deducted only up to the amount of money you made out of that hobby. Namely, that the expense is necessary for the hobby and that it is a common expense associated with the hobby.
  • Hobby expense limitations. As above, in most cases, hobby deductions are limited to the income received. If the hobby expenses exceed the income and result in a loss, this loss cannot be deducted against other income on the tax return.

Trump Tax Reform - itemized deductions use reduced

Hobby expenses are deducted along with other itemized deductions. Hobby expenses are classified as one of three types, and there are specific rules for each type. IRS Publication 535 contains more detail on these rules and how to use Schedule A to take the deductions.

However, it is important to note that with the latest tax reform (currently still being formulated in congress) - there is an overwhelming expectation that the standard deduction will double, and amount of  itemized deductions will be reduced. What this means in practice is that hobby expenses will be less likely to be utilized, as they are only helpful if you itemize.

Ines Zemelman, EA
Ines Zemelman, EA
founder of Taxes for Expats