Business or Hobby: How the IRS Decides

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Whether or not your business is considered a business or hobby greatly depends on your intentions going into it. Are you starting a business to turn a real profit, or is this just a fun way to make a few extra bucks? Keep reading to find out how the IRS decides whether your side hustle is a business or hobby.

Determine whether or not you are running a business or hobby

The IRS does not have clear cut expectations and rules to determine whether or not you have a business or hobby. They do, however, have guidelines. Deciding which one you have lies in your intentions. Is it simply a side hustle? Or are you working to build something you could live off of eventually?

Even if you have intentions to turn a profit and be classified as a business, there’s a chance it won’t happen right away. Some businesses need time to reach the point where they are considered a business by IRS standards.

You have to do it the right way. 

Put a business plan in place to show how you are working to improve profit and growth. It’s important to also ensure that you are keeping proper records of your finances throughout the year. You can easily track income and expenses through software like QuickBooks Online.

If you classified yourself as a business and had trouble bringing money in, you can declare business losses for up to three of the last five years. If you exceed the limit, you can be reclassified as a hobby. This could mean a large tax bill (retroactively placed on previous years taxes filed) so you need to consult a professional if you are approaching 3 years with all losses. 

Things to be aware of if you are classified as a hobby:

As a hobby, you most generally cannot take losses. According to this article, “Beginning in 2018, miscellaneous itemized deductions are no longer deductible and therefore no hobby expense is able to reduce hobby income.”

If you have questions about how you can easily classify yourself as a business, contact us! We would be happy to assist in setting up QBO or any other necessary software.

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