Most hobbies require spending money and don't really earn us anything, besides the occasional admiration from a fellow balloon animal enthusiast. A lot of them instead cost us a pretty penny – those balloons don't buy themselves, and practicing your craft involves a lot of wasted rubber. In order to offset the expenses, it can make sense to get on the kids' birthday circuit, where you can earn back a little cash.
But this presents another problem. If you're earning money on your hobbies, do you have to give Uncle Sam a share? It may seem silly to be taxed on a few hundred dollars of earned income from a hobby – and luckily, there's no need to panic if you haven't been declaring the twenty bucks you earn every February selling a few fancy balloon bouquets to your romantically minded friends.
However, the IRS does draw some lines between a for-profit business and a hobby. If you've been making money off your endeavor for three of the last five tax years, the IRS is going consider your venture a business, not a hobby, and you'll need to report the income like you would for any business you're running. On the other hand, if you lose money off of your hobby, you can't claim that "loss" as a deduction in the years when you don't.
Apart from that three-profitable-years guideline, there are a lot of rules separating businesses from hobbies. Fortunately, the IRS provides a "cheat sheet" of questions to help you determine if you've got yourself a fun side project or a ruthless cash venture:
- Does the time and effort put into the activity indicate an intention to make a profit?
- Do you depend on income from the activity?
- If there are losses, are they due to circumstances beyond your control or did they occur in the start-up phase of the business?
- Have you changed methods of operation to improve profitability?
- Do you have the knowledge needed to carry on the activity as a successful business?
- Have you made a profit in similar activities in the past?
- Does the activity make a profit in some years?
- Do you expect to make a profit in the future from the appreciation of assets used in the activity?
If you find yourself answering "yes" to a few of these, that balloon animal hobby is really a start-up business, and you'll need to plan your taxes accordingly.
- Bell, Kay. "5 Things to Know to Make Your Hobby Pay for Itself." ABC News. Feb. 22, 2014. (Sept. 17, 2014) http://abcnews.go.com/Business/top-tips-reducing-taxable-hobby-income/story?id=22608158
- H&R Block. "Hobby Income." 2014. (Sept. 17, 2014) https://www.hrblock.com/free-tax-tips-calculators/tax-help-articles/Small-Business/Hobby-Income.html?action=ga&aid=27154&out=vm
- IRS. "Is Your Hobby a For-Profit Endeavor?" June 2008. (Sept. 17, 2014) http://www.irs.gov/uac/Is-Your-Hobby-a-For-Profit-Endeavor%3F
- TurboTax. "When the IRS Classifies Your Business as a Hobby." 2014. (Sept. 14, 2014) https://turbotax.intuit.com/tax-tools/tax-tips/Small-Business-Taxes/When-the-IRS-Classifies-Your-Business-as-a-Hobby/INF22852.html
- Wang, Jim. "Does the IRS View Your Side Hustle as a Business or Hobby?" US News and World Report. April 1, 2014. (Sept. 17, 2014) http://money.usnews.com/money/blogs/my-money/2014/03/31/does-the-irs-view-your-side-hustle-as-a-business-or-hobby