Smart Money: Hobbies that Generate Income

If you like making jewelry or doing woodworking in your spare time... you might be able to turn it into a business.


·         Profits and losses from business activities are typically reported on Schedule C of Form 1040, but may also flow through to an individual’s tax return from S corporations or partnerships.

·         True business losses are often deductible and may offset wages and income from other sources.

·         Although businesses certainly may fail to generate profits, such losses receive scrutiny from the IRS.



·         Expense deductions associated with hobby activities are severely limited.

·         If an activity is a hobby instead of a business with a true profit motivation, the expense deductions will be limited to the amount of revenue earned.

·         Although this may initially seem to result in a break-even scenario for business income or loss, taxpayers should understand that the deductions will be miscellaneous deductions that are subject to income-related limitations.

·         Your hobby loss could actually generate taxable income on your tax return!



·         If your business generates a profit in three of the previous five years, the activity will be presumed to be a for-profit activity.

·         If the business does not generate a profit in three of the past five years this does not necessarily mean that the business will automatically be considered a hobby.  However, it does place the burden of proof on the taxpayer to prove that the activity is being conducted with a profit motivation.



·         True business activities typically require significant time and effort devoted to the enterprise.

·         Profit-oriented businesses should be run in a business-like manner.

   Utilize separate bank accounts for the business.

   Invest time and effort with a true intent to make the business profitable.

   Advertise and actively seek to expand the venture.

   Draft and follow a business plan.  Utilize budgets.

   Derive revenues from a diverse customer base.

   Consider incorporating the business or forming a limited liability company.

   Consider the need to hire managers or other employees.

   Seek the counsel of trusted advisors.

·         Create a track record that demonstrates devotion to profit-centered activities.

·         A reasonable expectation of asset appreciation may be a key factor.

·         Other than the three-out-of-five-years rule, there is not one single factor that dictates hobby versus business.  Taxpayers (and the IRS) must consider all factors in concert.



·         Activities that would normally be recreational for most individuals may, in fact, be a legitimate business for certain individuals.  However, such instances are rare.

·         If you operate a true business that would normally appear to be a recreational activity you should devote extra effort to ensure that you operate the activity in a true business-like manner!


Chris Harper

(© 2016 WZZM)


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