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Business vs. Hobby: An Important Distinction

It is vital to know the difference between a business and a hobby when it comes to taxes. Many times, a hobby turns into a business without the hobbyist meaning to. If you are earning an income from your hobby, then the IRS will require you to pay income tax on it.

If an activity is conducted with an intention to make profit, then it is considered a business. A hobby, on the other hand, is done for recreation or pleasure, and not for earning money. The eight factors that the IRS uses to determine if an activity is a hobby or a business are:

  1. Whether the activity is done in a businesslike manner.
  2. Whether the amount of time and effort you spend on the activity indicate that you want to make it profitable.
  3. Whether you depend on the income from the activity for your livelihood.
  4. Whether you change your method of operating with an intention to make the activity profitable.
  5. Whether you, your helpers or advisors have the knowledge and skills to turn the hobby into a successful business.
  6. Whether in the past you had turned a similar hobby into a successful business.
  7. Whether the activity has made a profit, how much profit it made, and whether there is a possibility of it making profit in the future.
  8. Whether the losses you incur are typified by a business in its startup phase.

How you report income from a hobby is different from how you would from a business. Even if your activity is a hobby and you earn an income from it, you can deduct certain hobby deductions to lower your tax liability. You cannot deduct your hobby expenses that are in excess of your income.

To deduct expenses, you need to itemize your deductions on your return. You may use the IRS Free File to file your tax return.