Is Your Side Hustle a Hobby or a Business?
With the rise of the gig economy, a lot of people have opted to turn their hobbies into profitable ventures. In turn, the lines are blurring between hobbies and small businesses, provoking many people to wonder what it means for their taxes. So, what is the difference?
The difference between hobbies and businesses
When thinking about the answer to that question, ask yourself whether the activity in mind is carried out for personal pleasure or to generate profit. See, the greatest differentiating factor between hobbies and businesses is that a business operates with the intention of making a profit, whereas a hobby is pursued for recreational purposes.
If you profit from your venture, the money you make is considered taxable income, which must always be reported on tax returns. So, just like other forms of income, any money you make from your side hustle is taxable. Even if the money doesn’t stem from full-time work, it still counts as a source of income.
How are tax forms changing with regard to hobbies?
Up until 2025, miscellaneous itemized deductions can be deducted. However, come next year, these details will no longer be deductible, meaning expenses related to your hobby cannot be used as a way to reduce expenses from that hobby.
That’s why many people are quick to transform their side hustles into businesses, and this comes down to deductions.
Questions to ask when determining whether your project is a hobby or a business
- Do you perform the activity in a businesslike manner?
- Is it protocol to keep a complete and accurate recording of your books?
- Does the time and effort you put toward your activity indicate that profits are the end goal?
- Have you made a profit from the activity, and if so, how much has been generated?
- Do you anticipate making a profit from the appreciation of the assets related to the activity in the future?
- Does your livelihood depend on any income that you generate from the activity?
- Are any losses that you experience due to the activity caused by circumstances beyond your control, or are the losses typical regarding the startup phase of a business?
- Do you adjust your methods of operation with the intention of improving profitability?
The importance of good recordkeeping
When operating a business, recordkeeping is key because it makes everything simpler when it comes time to file taxes. But where are some of the pain points associated with this in your eyes?
For instance, has your business claimed a net loss for many years in a row? If so, the IRS may classify your endeavors as a hobby rather than a business, which will ultimately prevent you from claiming that collective loss in your favor.
That’s why this is important to think about, as the onus is on you to prove that you had a valid profit motive to claim deductions. In short, if you start a business with the intention to make money eventually, the IRS will respond accordingly. If you don’t, your endeavors are more of a hobby than a business.
The IRS safe harbor rule
If you have turned a profit with your activity in at least three out of five consecutive years, then the IRS will view you as being engaged in the activity for the sake of making a profit.
Keeping accurate and extensive records of any profits you accrue can help you prevent your business from being classified as a hobby and subsequently losing your ability to benefit from deductions. By keeping records and holding onto receipts, you can document your motive behind any profits, which may demonstrate a more professional approach to your business.
A written business plan is often a prerequisite when you want to indicate your intent for profit. It can also portray the ways that you actively modify your business to cope with any losses you face.
Determining whether your activities are primarily carried out for enjoyment purposes or with the goal of making a profit will affect your ability to benefit from tax deductions. Think about what makes the most sense for your situation and proceed from there.
