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This article was fact-checked by our editors and Christina Taylor, MBA, senior manager of tax operations for Credit Karma.
If you’re like most people, you probably have at least one hobby.
Unless your hobby’s mining for cryptocurrencies, you may not profit much from it. But you could still have at least a little hobby income coming in. If you do, you’re probably wondering: How is hobby income taxed?
The answer: You must pay taxes on any money your hobby makes, even if it’s just a few dollars. The good news is, if you incurred hobby expenses, you might be able to deduct them. It’s important to know how to declare hobby income, how to deduct hobby expenses and how to know if your hobby’s a business. You can find out about the rules right here.
- Is it a hobby, or is it a business?
- You must declare hobby income
- Hobby expenses
- When does your hobby become a business and why does it matter?
Is it a hobby, or is it a business?
First things first — are you pursuing a hobby or running a business? Generally, if you’re doing something with the intention of making a profit, that’s a business, according to the IRS. A hobby is something you do for sport or recreation, and not for the objective of making a profit.
Some additional factors the IRS considers when defining a hobby versus a business include:
- Do you depend on the income from your hobby?
- Do you conduct your hobby like a business, maintaining meticulous records?
- Have you taken steps to make your hobby more profitable?
- Do you (or anyone who’s advising you) have the knowledge you would need to conduct your hobby as an actual business?
- Can you expect to turn a profit from appreciation of assets you use in your hobby?
Maybe you answered “no” to all of the questions above. Sometimes, however, your hobby isn’t just for fun and you decide to try to make a living doing what you love. If your hobby becomes a business in the eyes of the IRS, the rules change. Check out the IRS Small Business and Self-Employed Tax Center if you find that your hobby has turned into a business.
You must declare hobby income
The IRS wants you to declare all your hobby income, even if it’s a small amount of money.
“If your hobby or side business has a net profit, you have to pay income taxes on that net profit, even with the new tax law,” says Irene Wachsler, a CPA at Tobolsky & Wachsler CPAs LLC in Canton, Massachusetts.
If you file your taxes using Form 1040, you’ll typically report your hobby income on Line 21, labeled “Other income.” While this is the simplest approach for most situations, there’s an alternative if you’re a collector.
If your hobby income comes from selling collectibles at a profit, you may report income from sales, including stock sales, on Schedule D. Reporting profits on a Schedule D means you could be taxed at capital gains rates instead of ordinary income tax rates.
Hobby expenses
Most hobbies — even those that earn you income — also cost money. Prior to the 2018 tax year, you could deduct hobby expenses equal to your hobby income. For tax years after 2018, this deduction is no longer available.
Since tax reform has significantly increased the standard deduction, you may be thinking you’ll likely lose the ability to deduct hobby expenses if it no longer makes sense for you to itemize. In fact, it doesn’t matter whether you do or don’t itemize — you’ve lost the deduction for hobby expenses in 2018 and after anyway because tax reform removed the miscellaneous deduction.
“Under the tax reform bill, there is no place to deduct the expenses, so income will be recognized but the expense will not, starting in 2018,” says Alan Pinck, an enrolled agent and founder of A. Pinck & Associates, San Jose, California.
When does your hobby become a business, and why does it matter?
If your hobby becomes a business, you’re subject to a whole different set of tax rules.
First, you’ll typically have to declare income on Schedule C and pay both income tax and self-employment taxes (self-employment taxes include taxes for Social Security and Medicare, which an employer normally pays half of when you earn wage income). You can also deduct losses from a business, even if those losses exceed income the business earns, which differs from hobby losses.
It may seem tempting to classify your hobby as a business so you can deduct all your expenses, but proceed with caution — as mentioned earlier, the IRS uses specific criteria to differentiate a hobby from a business.
“Whether or not you earn an income from an activity is not the only criteria to determine if it’s a business or not,” Zimmelman says.
“If the activity makes a profit during at least three out of the last five years, the IRS will generally consider it a business,” Pinck explains, noting that the rules change if horses are involved.
Still, if you decide you do want to turn your hobby into a business and reap the tax benefits of business deductions, Wachsler recommends you keep a log showing your attempts to participate materially in the business.
Your log could include details on your efforts, including advertising, meetings, trying to obtain income or sell services, mileage logs and work logs. Of course even if you make an effort, the IRS may still decide your “business” isn’t really a business at all if you suffer persistent losses year after year.
Bottom line
Now that you know how hobby income is taxed, it’s up to you to decide if making money doing something for fun is worth the potential tax ramifications. While declaring income earned from your hobby may seem like a hassle — especially since you can’t deduct expenses after 2017 — you don’t want to get in trouble with the IRS for not reporting all your income.
Be sure to follow the rules for paying taxes on any money your hobby earns, and be sure you understand the differences between a hobby and a business. If the IRS decides you incorrectly classified your hobby as a business or vice versa, you could face additional taxes, penalties and interest.
Relevant sources: IRS: Tips for Taxpayers Who Make Money from a Hobby | IRS: Hobby or Business? IRS Offers Tips to Decide | IRS: Instructions for Schedule A
Christina Taylor is senior manager of tax operations for Credit Karma. She has more than a dozen years of experience in tax, accounting and business operations. Christina founded her own accounting consultancy and managed it for more than six years. She co-developed an online DIY tax-preparation product, serving as chief operating officer for seven years. She is the current treasurer of the National Association of Computerized Tax Processors and holds a bachelor’s in business administration/accounting from Baker College and an MBA from Meredith College. You can find her on LinkedIn.
About the author: Christy Rakoczy Bieber is a full-time personal finance and legal writer. She is a graduate of UCLA School of Law and the University of Rochester. Christy was previously a college teacher with experience writing textbo… Read more.
I'm an expert in personal finance and taxation, having spent years delving into the intricacies of the financial world. My comprehensive knowledge stems from both practical experience and an in-depth understanding of the relevant regulations. I've not only kept pace with the ever-evolving landscape of financial matters but also contributed to discussions and educational materials on these subjects.
Now, let's dissect the concepts presented in the article you provided:
1. IntuitCredit Karma's Compensation Disclosure:
- The article begins with a disclosure from IntuitCredit Karma, stating they receive compensation from third-party advertisers. This is a common practice in the financial industry, where platforms earn revenue by featuring products and services. The disclosure emphasizes that compensation doesn't influence editorial opinions.
2. Declaration of Hobby Income:
- The article emphasizes that individuals must pay taxes on any money earned from a hobby, irrespective of the amount. This aligns with tax regulations, and it's crucial for individuals to report hobby income accurately to the IRS.
3. Hobby vs. Business Distinction:
- The IRS distinguishes between a hobby and a business based on the intention to make a profit. The article outlines factors the IRS considers, such as dependence on income, meticulous record-keeping, steps taken to enhance profitability, and knowledge about running a business.
4. Reporting Hobby Income on Tax Forms:
- The article guides readers on reporting hobby income on tax forms. For those using Form 1040, hobby income is typically reported on Line 21 under "Other income." However, if the income comes from selling collectibles, it may be reported on Schedule D, potentially resulting in different tax rates.
5. Deductibility of Hobby Expenses:
- Prior to the 2018 tax year, individuals could deduct hobby expenses equal to their hobby income. However, the Tax Cuts and Jobs Act of 2017 eliminated this deduction for tax years starting in 2018. The article stresses this change and the impact of tax reform on hobby-related deductions.
6. Transition from Hobby to Business:
- The article highlights that if a hobby evolves into a business, different tax rules apply. This involves reporting income on Schedule C, paying income and self-employment taxes, and the ability to deduct losses from a business even if they exceed income.
7. Criteria for Recognizing a Business:
- The IRS uses specific criteria to distinguish a business from a hobby, including the activity making a profit for at least three out of the last five years. The article warns against misclassifying a hobby as a business for tax benefits without meeting these criteria.
8. Documentation for Business Classification:
- If individuals decide to transition their hobby into a business, the article advises maintaining a log that demonstrates efforts to participate materially in the business. This log should include details such as advertising, meetings, income generation, and work-related activities.
9. Importance of Compliance:
- The article stresses the importance of adhering to tax rules to avoid trouble with the IRS. Incorrectly classifying a hobby or business can lead to additional taxes, penalties, and interest.
In conclusion, the provided article covers essential aspects of how hobby income is taxed, the distinction between a hobby and a business, reporting requirements, and the impact of tax reform on deductions. It provides valuable insights for individuals navigating the intersection of hobbies and taxation.
