Know the Tax Consequences of Your Hobby - Rodgers & Associates

Know the Tax Consequences of Your Hobby

Many people enjoy hobbies that also provide a source of income. Whether you take up woodcarving, dog walking, or consulting, hobbies are a great way to spend your free time. One factor many people don’t consider when starting a new pursuit, however, is the tax impli­ca­tions of the income they receive.

To begin, ask yourself if your new activity is a hobby or a business. Distin­guishing between the two can be tricky, and the IRS lays out nine consid­er­a­tions to help taxpayers know the difference. The IRS classifies a hobby as an activity that, simply put, you engage in “for recre­ation or pleasure; not to make a profit.” The IRS also provides a safe-harbor rule, which presumes that an activity is a business rather than a hobby if it’s made a profit in at least three of the last five years.

If you answer yes to some of the IRS consid­er­a­tions or meet the safe-harbor rule, the IRS will most likely view your activity as a business. If you answer no to most of the questions and don’t meet the safe-harbor rule, the IRS could be more likely to classify your activity as a hobby.

If your activity is classified as a hobby, you will need to report any income you make from the activity on your personal tax return (Form 1040). The reported income is subject to income tax but not subject to self-employment tax (an additional 15.3%) as it would be for a business.

The downside of a hobby is that you cannot deduct any hobby-related expenses. Beginning in 2018, due to a tax-reform change under the Tax Cuts and Jobs Act (TCJA), you’re no longer eligible to take a deduction for hobby expenses due to the elimi­nation of miscel­la­neous itemized deduc­tions. (Note: The TCJA is set to expire in 2025 unless otherwise extended.) This means that while you can’t deduct any hobby expenses, you must still report 100% of hobby revenue as income and pay income taxes on it. And since you can’t use hobby expenses to reduce your hobby income, you won’t be able to use a loss from hobby sales to reduce other income. This can be important if you make money in other activ­ities that you intend to offset with losses.

Based on these parameters, it’s up to you to decide if making money doing something for fun is worth the potential tax ramifi­ca­tions. While declaring hobby income might seem like a hassle, you don’t want to get in trouble with the IRS for under­re­porting your income.

Be sure to follow the rules for paying taxes on your hobby earnings and know the difference between a hobby and a business. Consult your tax profes­sional or financial adviser for more direction on your situation. If the IRS decides you incor­rectly classify your hobby or business, you could face additional
taxes, penalties, and interest.