Are you a hobby or a business in the eyes of the IRS?

Are you a hobby or a business in the eyes of the IRS? Good question! Probably one that you haven’t or don’t ask yourself. But you should because it’s important.

The IRS normally views knitting and crocheting as hobbies. Really this applies to ANY type of handcraft or handmade item – jewelry, quilting, card making, candle making, sewing, etc.

Hobby or business – what’s the difference?

Let’s look at the terms hobby and business from the standpoint of the IRS a little more closely shall we and compare them.

Really, whether you are a hobby or a business is mostly (but not all) about INTENT.

When you make handmade items as a hobby, you:

  • do it mainly for relaxation or just because it’s something you like to do
  • make things YOU like to make
  • give the finished items as gifts or perhaps donate them to charity
  • sell them for the cost of yarn (materials) PLUS a couple of bucks for yourself
  • are selling things to fund the cost of your materials stash

When you make handmade items as a business, you:

  • intend to make a profit from the sale of the items
  • make sure your business has it’s own identity
  • register your business with all the proper government agencies
  • have and can claim expenses other than just materials
  • do market research on current trends and what’s popular and make items based on those findings
  • can provide documentation proving the time and effort that you put into running a business – this is the BIG one (and why I harp so much on doing your bookkeeping)!

The IRS provides the following guidance in an IRS Tax Tip, dated August 25, 2020 to help you determine if you are a hobby or a business. I’m providing it below:

  • Is the activity is carried out in a businesslike manner and the taxpayer maintains complete and accurate books and records. 
  • Does the time and effort the taxpayer puts into the activity show they intend to make it profitable. 
  • Do they depend on income from the activity for their livelihood. 
  • Are 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. 
  • Does the taxpayer and their advisors have the knowledge needed to carry out the activity as a successful business. 
  • Was 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.

Let’s dispel some myths

hobby or business?There’s a myth that likes to flit around the internet like a butterfly that if you sell on-line (via Etsy, Ravelry, or elsewhere), you’re considered a hobby and you don’t need to report your sales income on your personal tax return.

 

You might see variations of this myth.

 

It might start with something like, “I’m just a hobby, so….” Or it might not even involve the trigger word “hobby”. It might be something along the lines of “you don’t need to report your income for taxes until you make $X.”

 

I hate to rain on your parade – but it’s NOT TRUE! You:

  • should be reporting hobby income on your personal tax return
  • self-employment taxes (15.3%) kick in as soon as you have $400.00 or more in NET earnings in a year (See the Self-Employed Individuals Tax Center on the IRS website, What are my self-employed tax obligations)
  • Federal Income taxes kick in as soon as you make between $5 and $15.00 (based on current IRS tax tables for a daily pay period when filing Single with 0 exemptions).
  • State (and perhaps Local) Income taxes also come into play.
  • if you sell on Etsy, Ravelry, at craft fairs, etc. you could very well have sales tax obligations

NOTE: At the end of the year, when filling out your tax return Federal, State, and Local Tax amount often change, because then you are looking at the totals for the year. In my opinion, it’s best to be prepared and start setting aside tax money each and every month.

From a tax perspective, what’s the difference between a hobby and a business?

Oh boy, it THAT a loaded question.

Basically it’s this.

As a hobby, you are supposed to report hobby income on your Form 1040 under OTHER INCOME. It then gets lumped together with your wages from a job (if you have one) and any other family income. Hobby expenses can no longer be deducted as of 2018.

Now, if you’re a business, you report ALL your business Income AND Expenses on a Schedule C (designed specifically for sole proprietorship’s and certain LLC’s who opt to file as a sole proprietor) in order to determine your NET Profit or Loss.

So, that’s all the “tax” advice that I’m going to offer. Remember I am not a CPA, but rather a bookkeeper who also has to know these things. I do recommend that you talk to your own CPA or tax professional about your specific situation.

Don’t freak out if you’ve been doing it all wrong – now you know better. You just need to change your ways and your thinking too.

7 Comments

  1. […] this blog post – Are you a hobby or a business in the eyes of the IRS – for more […]

  2. This post has so much information that I know I will look back at .. thank you..

    1. Vidya, you are so sweet! Thank you for your kind words.

  3. Taxes are tricky and I know several people who will benefit from this article and there not only a Handmade Business but a blogger as well as companies like Lawn Mowing and Home Decor. Thank you for answering questions I have been asked but didn’t know how to answer or what to tell them.

    1. Glenda, thank you for the kind words.

  4. Great advice to help people decide whether they are a hobby or for profit business!

    1. Thank you. Tax law is so difficult to understand.

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