If you have a fledgling or small sideline that you want to be able to call a “business” for IRS taxes, it is important to know what distinguishes a business from a hobby. A hobby may not give you deductions on your personal federal income tax return if you are perhaps a crafter or a good baker or like to make jewelry or knit and crochet baby outfits and make items for all ages, or so much more. You want to earn some extra money making use of your talents that are also a passion and give you and your customers pleasure.
No matter where any of your income originates, you are required to report it on your tax return even if it is determined to be a hobby. Therefore, it becomes crucial to know what expenses can help to lower the Internal Revenue Service taxes you may owe. When you have a business, there are a multitude of deductions that you can use, but they must be directly related to the operation of your specific enterprise’s money-making product or service.
If your expenses from a hobby/unincorporated sideline activity exceed the revenue, that is a net loss. You may think you can deduct that loss on your personal federal income tax return, but the tax results do not turn out satisfactorily if the money-losing activity must be treated as a not-for-profit hobby.
Expenses fall into three types of deductions with special rules applying to each type. Taxpayers must itemize deductions on Schedule A, Itemized Deductions, of their tax return to deduct and claim their expenses, whether they are business or hobby related.
The main consideration as a business
The main feature to determine a business is that you are doing it to make a profit. A hobby is engaging in an activity for sport or recreation and NOT to make a profit. Rules in the new Tax Cuts and Jobs Act (TCJA) for 2018-2025 are even more stringent. They say you cannot deduct expenses that are hobby-related, but you must report 100% of the hobby income and pay tax on it.
Other considerations that make it a business
* A for-profit business has POSITIVE taxable income in a minimum of three out of each five-year period. Losses in those “lean” years can be deducted because they are considered business losses and not hobby losses. Regularly money-LOSING sidelines are considered hobbies and not businesses.
* You must demonstrate that your honest intent is to make a profit.
• You must conduct the activity in a business-like manner by spending enough time and effort that justifies naming it a business, having the necessary expertise, keeping detailed records, searching for profit-making strategies, expecting appreciation of assets, and other criteria.
* The IRS will review the history of the income and losses. If you have large profits occasionally, they will help to outweigh any small profits, and losses that are caused by unusual events are more justifiable than ongoing losses.
* If you have or have had success in other ventures, that indicates your business experience and acumen.
Satisfying the IRS
You can see above why it is extremely necessary now more than ever to establish that a money-losing activity/hobby is actually a for-profit business that just has not had a chance yet to become profitable. Contact Bilsky Financial Group so we can explain the intricacies of what you have to provide as proof and how you can satisfy the requirements for IRS taxes.
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