Pursuing a skill or passion outside of the normal business day is a good way to live a balanced life. But what happens when that hobby starts making you money – perhaps even more money than your day job? Do you need to incorporate or pay taxes on the money your hobby generates?
The IRS has 9 factors to help determine what is – and is not – a tax-paying business venture. All these factors are considered holistically, and no one factor will determine whether or not you are running a business.
- If you operate in a businesslike manner
- If you put in time and activity intending to turn a profit
- If you depend on income from the activity for your livelihood
- If your losses are normal for your type of business or are out of your control
- If you make operational changes to improve profitability
- If you or your advisors have the know-how to carry on a successful business
- If you have had similar successful ventures in the past
- If your venture eventually makes a profit and how much profit
- If you acquire assets for the venture that will appreciate in value
In reality, this list of determining factors boils down to two issues: Whether you proport to be running a business, and whether the IRS thinks you’re running a business.
One main reason people make the leap from hobbyist to professional is because of money invested. It’s the difference between hiring the best CPA you can afford versus using a Turbo Tax coupon to get your taxes done. Under IRS rules, hobbies are not meant to be profitable, and so any money spent is money wasted, and any money accrued is personal. A business, however, can balance its liabilities against its assets, and take better advantage of tax loopholes. However, the case must be made for the 9 points above to convince the IRS that your business is not a mere hobby. Overall, treating your hobby like a business before it starts making money is the best way to prove intent.