From collecting stamps and woodworking to crafting and quilting, people have all kinds of hobbies – and most of these hobbies will never turn a profit. For hobbies that do earn income, people should know that they must report it on their tax return. They should also be mindful that their hobby might be a business.
Determining whether they should classify the activity as a hobby or a business can be confusing, but the bottom line is that a business operates to make a profit. People pursue hobbies for sport or recreation, not profit. There are a few other things people should consider when determining if their project is a hobby or business. No single consideration is the deciding factor, but taxpayers should review all of them when determining whether their activities are a business.
Here are the things taxpayers should evaluate to decide whether they have a hobby or a business:
• Whether the taxpayer carries out the activity in a businesslike manner and maintains complete and accurate books and records.
• Whether the time and effort the taxpayer puts into the activity show they intend to make it profitable.
• Whether they depend on income from the activity for their livelihood.
• Whether any losses are due to circumstances beyond the taxpayer’s control or are normal for the startup phase of their type of business.
• Whether they change methods of operation to improve profitability.
• Whether the taxpayer and their advisors have the knowledge needed to carry out the activity as a successful business.
• Whether the taxpayer was successful in making a profit in similar activities in the past.
• Whether the activity makes a profit in some years and how much profit it makes.
• Whether the taxpayers can expect to make a future profit from the appreciation of the assets used in the activity.