Is it a Hobby or a Business? How to Decide Before Tax Time

More Americans than ever have a side gig. In fact, a recent survey by Bankrate.com found that 37% of Americans make additional money from a job that is not their full-time gig, making $686 per month, on average. 

So what are Americans using this extra cash for? Well, 59% use this extra money as disposable income while 38% use the extra cash to cover living expenses. 

It's easier than ever to turn your hobby or skills into profit. With sites like Etsy available to sell homemade goods, Fiverr and Upwork to offer your skills for freelance work, Ebay or Poshmark to sell extra goods or used clothing, or Wordpress to turn your knowledge into a blog, the options are endless.  

If you're one of the 37% of Americans with a side gig, you'll have to determine whether the IRS views your hobby as a business and file accordingly. 

There are the nine factors that the IRS asks you to consider before making this determination. 

Questions to Ask Yourself to Determine if Your Activity is a Hobby or a Business

1. Do you carry on the activity in a businesslike manner and maintain complete and accurate books and records?
2. Does the time and effort you put in to the activity indicate that you intend to make it profitable?
3. Do you depend on the income from the activity for your livelihood?
4. Are your losses due to circumstances beyond your control? Or are they normal in the startup phase of a business?
5. Do you change methods of operation in an attempt to improve your profitability?
6. Do you or your advisors have the knowledge needed to carry on the activity as a successful business?
7. Were you successful in making a profit in similar activities in the past?
8. Does the activity make a profit in some years? How much does it make in profit?
9. Can you expect to make a future profit from the appreciation of assets used in the activity?

The IRS specifically states that no single factor is decisive. You must look at the answers to all of the questions above and make an honest determination.

What to Do if You Determine Your Activity is a Hobby

If you ask yourself the above questions and you feel confident that your activity is a hobby, you'll go ahead and add income (and expenses) as "miscellaneous hobby income" on your taxes. Some states will request that you provide a description of your hobby.

You are able to deduct expenses for your hobby, so long as they are "ordinary and necessary". You can read more about hobby expenses and how to deduct them here. 

What to Do if You Determine Your Activity is a Business

If you determine that your activity is in fact a business, you can proceed with filing a Schedule C (form 1040) with your taxes and report income from your business as a sole proprietor. You can find the Schedule C (form 1040) here. 

Most tax software such as TurboTax or H&R Block will require that you upgrade to their deluxe or premium product in order to add on the Schedule C (form 1040). 

The Future of Your Business

If you've determined that you have a business and are a sole proprietor of that business, it may be time to talk to your accountant or attorney about whether you'd benefit from forming an LLC. 

There are many benefits to forming an LLC including personal liability protection, management flexibility, and tax benefits, to name a few.

You do not have to form an LLC in your home state and many business owners choose to form Delaware LLCs, due to their ease of set up and low cost. You can learn more about why Delaware might be right for your business here. 

If you decide to set up an LLC for your hobby turned business, The Incorporators Ltd. is happy to assist you. We have over 35 years of experience and easy online ordering. Take a look at our LLC Packages and feel free to contact us with any questions.