It’s an Important Distinction – Are You Participating in a Hobby or Running a Business?

Woman making jewelry deciding whether it's a hobby or businessIs your hobby actually a business? While it may sound like semantics, the IRS notes that it’s an important distinction when it comes to taxes.

Moreover, some hobbies should actually be run as businesses. The key differentiator is this: businesses are operated with the intention of creating a profit, while hobbies are activities performed for pastime enjoyment and do not generate income. So if you have a profitable hobby, you may need to consider turning it into a business. In addition, the IRS is reminding taxpayers in Tax Tip 2022-106, published Wednesday, that any hobbies producing an income must be reported on tax returns.

Is it a Hobby or Business?

So how do you know if your passion for making jewelry or building wooden tables should be classified a hobby or a business? According to the IRS, taxpayers should review the following nine questions when making the determination; however, no one factor is more important than another, and all should be considered when determining whether your hobby should be a business:

  • Is the activity is carried out in a businesslike manner, and does the taxpayer maintain complete and accurate books and financial records?
  • Does the taxpayer’s time and effort related to the activity show intention to make it profitable?
  • Does the taxpayer depend on the activity’s income for his or her livelihood?
  • If there are any losses, are they a result of circumstances beyond the taxpayer’s control or normal for the startup phase of the business?
  • Does the taxpayer change methods of operation to increase profitability?
  • Does the taxpayer and/or any advisors have the knowledge necessary to conduct the activity as a profitable business?
  • Has the taxpayer successfully generated a profit while performing similar activities in the past?
  • Does the activity make a profit some years? If so, how much profit does it make?
  • Can the taxpayer expect to make a future profit from the appreciation of assets used in the activity?

If a taxpayer receives income from an activity that is carried on with no intention of making a profit, they must report the income they receive on Schedule 1, Form 1040, line 8.

For more information on distinguishing between businesses and hobbies, review the IRS’s tax tip, or contact your HW&Co. tax advisor for guidance.