​Hobby Income: Is It Taxable?

All hobby income is taxable. Simply stated, if you make money from a hobby or business, you are required to report it to the IRS. To determine how to appropriately report and classify your income, you must first determine if the IRS considers your hobby a business or not. Some taxpayers think it is best if their hobby income is not considered a business. However, for tax purposes, especially with the New Tax Reform, it is better, if you can consider your hobby a business.

Does the IRS Consider Your Hobby a Business?

The IRS defines a hobby for tax purposes as “an activity not engaged in for profit.” If you are taking pictures, playing the cello, making crafts, training horses, or any other number of various activities to make a profit, then the IRS determines, for tax purposes, you are running a for-profit business, not a hobby. You probably are thinking, like many other taxpayers, it is better if I can consider my extra income as a hobby, right? For tax purposes, it is better if your hobby can be considered a business, if you make any income from its operation. If not, you must pay taxes under the New Tax Reform on 100% of your hobby income, regardless of your expenses. Aunt Barbara’s knitting just became even more valuable. If it falls under the IRS guidelines for a business, this means you can deduct your business expenses from yarn to mileage. Many people do activities because they enjoy them and not because they depend on the money they make from these activities. It is in these circumstances that it gets even more complicated to determine whether the IRS considers your hobby a business or not. If you are not sure whether you are engaged in the activity for profit, the IRS lists the following eight (8) factors for taxpayers to consider in helping them make the determination of whether they should consider their extra income as a hobby or business:

• Does the time and effort put into the activity indicate an intention to make a profit?
• Does the taxpayer depend on income from the activity?
• If there are losses, are they due to circumstances beyond the taxpayer’s control or did they occur in the start-up phase of the business?
• Has the taxpayer changed methods of operation to improve profitability?
• Does the taxpayer or his/her advisors have the knowledge needed to carry on the activity as a successful business?
• Has the taxpayer made a profit in similar activities in the past?
• Does the activity make a profit in some years?
• Can the taxpayer expect to make a profit in the future from the appreciation of assets used in the activity?

Basically, the IRS determines the hobby is operated as a business and should be taxed accordingly, if you have made a profit from the business in two (2) out of the past five (5) years, which includes the current tax year. This timeframe expands to two (2) out of the past seven (7) years, if the activity involves “primarily of breeding, showing, training or racing horses.” Unlike self-employment income, hobby losses and / or expenses may not be used to offset any income, including the hobby income itself. This is key. For example, if you earn $30,000 from your main W-2 job and earn an additional $10,000 for your side job driving for a rideshare company, your total income is $40,000. However, if your ridesharing jig resulted in $12,000 in expenses, equal to a $2,000 loss ($10,000 - $12,000), you would be able to deduct that $2,000 from your $30,000 W-2 income. This would result in you having only $28,000 in taxable income, and this is before any deductions, including the standard deduction, are taken. If your ridesharing job is considered a hobby, typically, it is not, you would not be able to deduct the $12,000 in expenses. This would result in you paying taxes on the full $40,000 of income! This means the IRS would require you to pay taxes on an additional $12,000 of income, that you would not need to pay taxes on, if it was considered business income. If you can qualify to classify your hobby income as a business and track your expenses, it could save you thousands on your federal income taxes. In the example above, if the taxpayer was in the 24% tax bracket, they could save $2,880 ($12,000 x 24%) by classifying their hobby as a business for tax purposes.

Hobby Income Deductions and the New Tax Reform

If the income you earned is not for profit and considered a hobby by the IRS, in the past the expenses you paid to participate in your hobby were claimed on Schedule A, as miscellaneous itemized deductions. Under the New Tax Reform, miscellaneous deductions have been eliminated. No more expenses can be deducted to offset hobby income. This means all money received from hobbies, whether profit or not, is taxable. OUCH!

The Bottom Line

Claim your hobby income as business income, if at all possible. Otherwise, be prepared to pay taxes on 100% of your income earned from your hobbies. However, be careful, as the IRS will be watching people claiming losses on businesses even more closely now that guidelines have gotten stricter on hobby income. Remember you will be safe if your side job has earned a profit for two (2) out of the past five (5) years (two (2) out of the past seven (7) years if it involves breeding, showing, racing, or training horses). If you can qualify your hobby income as business income for tax purposes, you will be able to deduct expenses, which will equal a huge savings on your taxes. There can be circumstances, if you are not operating at a loss, when it is best to classify the income as hobby income, if you qualify. To determine the best way to classify your extra income, either as business or hobby income, contact the tax preparation professionals at Gudorf Tax Group and schedule an appointment today.