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Learning the IRS Rules
It seems like everyone has a side hustle these days, but is your side hustle a hobby or business? Even if you consider it a business, in the US, the IRS may not agree. Knowing the distinction between business and hobby is important and getting it wrong may result in serious consequences. Whether you’re just trying to earn a little money on the side, diversify your income stream or turn your side hustle into a full-time gig, make sure you know how to avoid having your status challenged by the IRS.
A trade or business can offset taxable income with “ordinary” and “necessary” business expenses. Ordinary means the expense is common and accepted in that industry. A necessary expense is one that is appropriate for the business. A sole proprietor who reports a net loss on Schedule C of Form 1040 can use that loss to offset other income, including wages, interest, dividends, etc.
If you earn income from a hobby (not an official business), that income must still be reported on Schedule C of your tax return. However, expenses of the hobby cannot be netted against hobby income. Instead, hobby expenses are claimed as miscellaneous itemized deductions on Schedule A and your hobby expenses are limited to the amount of hobby income. In other words, your hobby business cannot generate a net loss.
A business that has been operating at a loss for several years runs the risk of being challenged by the IRS and having their tax liability recalculated under hobby loss rules.