Hobby Income Taxes 101: Everything You Need to Know About Hobby Tax Rules
Hobby Income is the money you make while doing what you love without expecting to earn profit from it. There are no restrictions on making money from a hobby but once you earn a few bucks, there will be tax consequences. In this article, you will learn about the rules related to hobby income taxes.
What is a hobby income?
If your intention is to engage in an activity for sports or recreation and it happens to provide you with the extra income, you are making hobby income.
There are plenty of activities that you do as a hobby that can generate income especially in the times when the internet has provided us with multiple platforms to showcase our talent. Let’s look at some of these activities that can become your side hustle.
Before the advent of the internet if you loved to write you would fill your journals. But now when you are ready to write you simply pen it down either on your personal blog or any other platform that allows the self-published authors to share their stories and ideas.
Imagine your blog became popular and people admired your writing skills. They have been contacting you to write for them. You did a few projects and it is now becoming an activity that is generating a fair amount of income. At this point, you will need a tax guide for bloggers.
Almost every other person is running a blog nowadays. For some it is a hobby, for others, it is a way to generate passive income.
You love capturing moments in your free time. Your social media walls are filled with the photographs you took in your leisure time. One of your friends liked your skills and wants to hire you as a photographer for an upcoming event. He offered to pay a reasonable amount and you agreed to it. This hobby income will have an impact on your tax returns.
You are interested in visual communication and practice graphic designing in your leisure time. You self-taught yourself by watching free online tutorials. You use Canva or some expert software like photoshop or illustrator to design.
You are also looking into advancing your skills. Out of fun you posted a gig on an online marketplace and got hired by a few clients who paid you well.
There are plenty of activities online and offline that can generate additional income. You need to remember that the moment you start earning from your hobbies there are going to be tax implications. We are now going to look at the rules for hobby income taxes.
What are the rules for hobby earning tax?
There are 4 main questions that you might be asking when dealing with hobby income taxes.
Do I have to pay taxes on hobby income?
Yes, as soon as the money starts coming in from your hobby you need to report it.
In today’s world, individuals are now able to demonstrate their skills, which are acquired out of pure interest, on social media and other digital platforms. The IRS recognizes it as a "Gig Economy" and defines it as follows
"The gig economy—also called sharing economy or access economy—is an activity where people earn income providing on-demand work, services, or goods. Often, it’s through a digital platform like an app or website."
You are required to report your earnings from the digital platform on your tax return regardless of whether or not it is a hobby income.
When does my hobby income turn into business income?
The IRS uses nine factors to determine if your hobby income has turned into business income.
Imagine your side hustle starts taking up more of your time and you finally decide to take it more seriously and contemplate turning it into a full-time job.
The IRS uses the following nine factors to determine when does your hobby Income turn into a profit-making business income.
- How do you carry out your activity?
- Your dedicated time and effort.
- Your personal motive behind the activity.
- You are making losses that are beyond your control and are considered normal for the activity you undertook.
- Is it the only income-generating activity for your livelihood?
- The profit and losses you have made so far in relation to your activity.
- The expertise you and your team possess.
- The assets you use have the potential to earn gain if sold because of the appreciation of its value.
- The extent to which your activity has been profitable.
Furthermore, If you have made a profit in at least three of the past five years it is very likely that your activity will be presumed to be a business rather than a hobby. This is the IRS safe harbor rule.
Are there any allowable tax deductions for hobby income?
Before 2018, you could deduct expenses as an itemized deduction. But there was a limit on the extent to which you could claim it. For instance, let’s suppose you were generating additional income from providing freelance writing services on an online marketplace in 2017. You did not intend to make any profit from it. In this case, if what you spent is more than what you earn then you will have to bear it as a personal loss.
Starting from the year 2018, the IRS no longer allows you to deduct hobby expenses to arrive at a taxable hobby income.
If your activity is considered as a business for tax purposes you are self-employed. And you can reduce your income by deducting business expenses that are ordinary and necessary in carrying out your trade. Following are some of the expenses that you might be able to deduct.
- Home office tax deductions
- Travel expenses
- Start-up costs
- Professional Fees
- Education and licensing cost
What are the relevant forms you might need for reporting hobby income?
Once it is certain that an activity is a hobby, any income you receive from it will be reported on Schedule 1, line 8 of Form 1040. You will not have to pay self-employment taxes on this income.
However, if your income from the activity is considered a business then your income will be taxed depending on the business structure you choose. You can either file your taxes as a sole proprietorship or LLC whichever suits your circumstances. In the future, your business might grow to an extent that you may see the benefits for it to register as a corporation.
Generally, you would be considered a self-employed individual and will use Form 1040 to report your earnings during the year.
Form 1040-ES is used to determine your estimated quarterly taxes. It is a form you might need if your expected tax liability is $1000 or more after taking into account the deduction.
If you have no idea how to figure out whether your activity is still a hobby or has turned into a business consult a tax expert. He will ensure your taxes are filed with accurate numbers claiming all the allowable deductions and tax credit you are eligible for.