3 Tax Questions to Ask Before Claiming a Hobby as a Business
What happens if a hobby becomes more than a hobby? Maybe a brewing hobby has led to a passion and some great brews that you want to branch out and pursue brewing as a full-time career. Maybe a farming hobby brought in more of a profit than you expected and you want to shift more resources into making it your life’s work. Or perhaps you have chosen to increase a pastime spent woodworking into your profession.
Anyone that finds themselves making this transition has a number of questions. A wise entrepreneur will set up a business plan and look into business formation options for liability protection and tax savings. The thought of taxes may trigger another question — can you shift what the Internal Revenue Service (IRS) views as a hobby into a business for tax purposes?
Why does this matter?
One key reason: deductions. The IRS allows businesses certain tax deductions that are not present for hobbies. As a result, it can be financially helpful for the IRS to agree that your hobby is now a business.
How do I establish my hobby is a business?
One of the most important things you can do to help defend your designation as a business is to keep good records. Have paperwork to back up the claim that you are operating as a business, not just a hobby.
What will the IRS look for?
The agency has many tests to determine if the claimed business is truly a business or just a hobby. One test: is it making a profit. In most cases, the IRS expects a business to make a profit in three out of five years it is operating. Another example: have a separate credit account or banking account for the business.
