In light of so many surprises and tax law changes, it’s always best to stay prepared. Yesterday was tax issues from payment apps; today, it’s the tight restrictions on ERC claims, and tomorrow might be a different story. What’s with the hobby versus business issue again? Looking at the data profile of these IRS surprises, you’d think the IRS is going all out for a hunt on small businesses.
Does it matter if you spend $600 on your hobby or to promote your side hustle so you can be extra money? It sure does if you want to keep the IRS happy.
Operating a business on the side gives you extra income and valuable tax deductions, but the IRS decides if the business can be classified as a hobby. If the IRS says it’s a hobby, you could lose the opportunity to deduct the expenses from your income.
Where Do You Fit?
The way the world works now, everyone wants a little side business. Whether you’re selling your handmade crafts on Etsy or simply helping people decorate their homes on the side, there’s no better way to make some extra money than doing something you’re passionate about. But when does your hobby pass the IRS checklist as taxable income?
You’ll ask, can’t I just make some side money off my hobby without the IRS interfering? It’s as if the IRS is waiting by the corner every time you get a nickel. But the fact is that it’s best to meet the IRS criteria to maximize your tax benefits.
But the top trick that can help you scale through this is understanding how to navigate these boundaries legally. The IRS defines a hobby as something you do for pleasure without expecting to make a profit from it. While you can’t deduct the cost of your hubby from your taxes, if you make a profit and meet the business eligibility criteria according to the IRS, you could deduct the cost from your business.
How Does The IRS Identify Your Activity As A Business?
The IRS has created a 9-factor authenticator to help you determine where you belong.
- Whether the activity is carried out professionally and you maintain complete and accurate records
- Whether the effort and time put into the activity prove they intend to make it profitable.
- Whether you depend on the income from the activity for their livelihood
- Whether losses due to circumstances beyond your control or considered normal for businesses in the first phase
- Whether you changed methods of operation to increase your profitability.
- Whether you and your advisor have the knowledge to carry out the activity as a successful business
- Whether you were successful in making a profit from a similar business activity in the past
- Whether the activity will be profitable in some years and how much profit it will make.
- Whether you can expect to make a future profit from the appreciation of the assets used in the activity.
How Much Money Can You Earn From A Hobby Before Paying The Tax?
In the real sense, the moment you start making money from your hobby, even if you earned a few dollars, you need to declare it; your income determines whether you’ll have to pay taxes or not.
The great thing is that if your activity is truly a hobby and you aren’t making money from it, you don’t need to pay taxes, but if your business checks the IRS eligibility criteria, you’ll have to pay taxes.
The IRS does not differentiate your hobby income from the rest of your income in a tax year. But if your hobby income and your primary source of income in a year exceed the limit set out by the IRS, you must include them in your Form 1040.
If you’re under 65 and filing as an individual, the IRS requires you to declare your hobby earnings, a total of $12,400 or more, when combined with your primary income. If you’re married and filing jointly, the IRS threshold is $24,800 if both spouses are under 65.
Do I Need To Register My Hobby As A Business?
Whether or not you need to register or have a license for your hobby depends on the IRS guidelines. Since the IRS sees a business as an attempt to make a profit, you might not need to register your hobby as a business if you’re not earning money from it.
How To Turn Your Hobby Into A Business
One of the best things about running a business is that you can write off your business expenses from your taxes. By running a business, you can make significant income from your passion, become your boss, and be eligible for small business loans or grants to pursue your passion.
If you have decided to make a profit and turn your hobby into a small business, you need to take the necessary steps and meet the IRS criteria. This will help the IRS recognize your hobby as a business and prevent the IRS from challenging your tax claims. Here’s how you can turn your business into a hobby.
- Keep accurate records: for your hobby to be recognized as a business, you need to keep accurate records of all your business activities, log your transactions and send your formal invoices to make your taxes easier at the end of the year.
- Make a business plan: having a business plan helps your business stay profitable and shows the IRS that you are really serious about your business. Remember that the IRS wants to know that you depend on the profit as part of your livelihood.
- Get the license: if the business requires a license to operate, take the necessary steps to get it. This will show the IRS that you are genuinely operating a business and make you eligible for tax deductions.
- Keep a separate account: having a separate business account boosts your credibility and helps you sort your taxes easily.
What If The IRS Asks For Proof?
If you keep accurate records for all your business activities, then showing the IRS proof shouldn’t be a problem. Ensure you meet the requirements as a business and have proof of the income received from the service you rendered to maximize your tax deductions.
How your taxes are handled depends on whether your activity is classified as a business or a hobby. If you want to make a profit and write off your business expenses from your taxes, then the IRS needs to see you as a business owner.
While owning a business provides more tax deduction opportunities, it also means you might be liable to pay more taxes if you make more profit, and that is why you need to work with an expert tax expert like Tax Goddess.
At Tax Goddess, we love helping you turn your passion into a tax advantage and back you up with legal tax strategies to ensure you can keep your hard-earned money in your pocket. We understand the importance of setting up a realistic tax plan to meet your financial goal and keeping the book straight with the IRS. If you want to maximize tax opportunities in 2023, get on board with our expert tax team today!