| Many people enjoy hobbies that cost quite a bit | | | | profitable -- you can report it as a business, even |
| of cash to maintain and may even earn a little bit | | | | if you show a loss in the current year. If, |
| back. Unfortunately, the expenses of a hobby can | | | | however, you continue to report a loss year after |
| only be deducted from your personal taxes up to | | | | year, and do not show a profitable year for |
| the amount your hobby earns. For example, one | | | | several years straight, the IRS may take a |
| hobbyist makes quilts and spends an average of | | | | second look at your taxes (read: IRS |
| $500 per month on materials and travel to quilt | | | | audit)...definitely not an outcome worth the few |
| shows. He won two prizes last year of $1000 | | | | hundred dollars you might save on your annual |
| each, and sold several quilts for a total of $2500. | | | | tax return. |
| As a hobby, only up to $3500 of the expenses | | | | Generally, a hobby becomes a business when and |
| could be deducted, even though about $6000 was | | | | if your purpose for the activity is to make a |
| spent. If the activity was classified as a business | | | | profit, you depend on the income from the |
| instead, all of the "ordinary and necessary" | | | | activity, and/or you actually do profit from the |
| expenses could be deducted as a business loss. | | | | activity most years. The advantage of filing the |
| The question is, at what point can a hobby be | | | | activity as a business is that you can write off |
| reclassified as a business? | | | | your losses when they occur, and the |
| There are a number of factors that separate a | | | | disadvantage is that you are taxed on the profits |
| hobby from a business, most of which are based | | | | the other years as additional ordinary income. The |
| on the profitability of the activity. The IRS refers | | | | earnings in a profitable year do not have to be |
| to hobbies as "not-for-profit activities" -- meaning | | | | extravagant. Technically, earning one dollar more |
| that you do not do the activity with the intention | | | | than you spent is turning a profit, though the IRS |
| of clearing a profit. If you are doing what you do | | | | might be suspicious if you profit only one dollar |
| just for fun and really don't care whether you | | | | per good year and lose thousands on a bad year! |
| turn a profit or not, it is a hobby. It is possible for | | | | The bottom line is that if you want to turn your |
| a hobby to make a profit, but that is usually a | | | | hobby into a business for tax purposes, you |
| fluke. A hobbyist does not take any measures to | | | | actually need to turn it into a legitimate business. |
| ensure a profit is made, and does not generally | | | | A legitimate business makes operational changes |
| maintain records and incorporate business | | | | to control expenses and increase income. It |
| principles in managing the activity. | | | | maintains basic accounting records and follows |
| The IRS standard for an activity to even qualify | | | | basic business principles. The owner's primary |
| as a business is that a profit is earned in at least | | | | motivation in business is to make money, and |
| three of the last five years. Of course, if you | | | | most business owners would not continue with an |
| have not kept records or have recently started | | | | activity that doesn't improve their personal wealth. |
| this activity, you may not have these types of | | | | If you are not interested in the effort required to |
| records. Consider the likelihood that this will be | | | | turn your hobby into a business, simply continue |
| true over the next five years. If you are willing to | | | | to keep your receipts so that you can write off |
| treat the activity as you would any other | | | | expenses up to the amount of money your |
| business - by monitoring the financials, maintaining | | | | hobby brings in. |
| business records, and finding ways to make it | | | | |