IRS Summertime Tax Tip 2014-15
Five Basic Tax Tips about Hobbies
Millions of people enjoy hobbies that are also a source of income. Some examples include stamp and coin collecting, craft making, and horsemanship. You must report on your tax return the income you earn from a hobby. The rules for how you report the income and expenses depend on whether the activity is a hobby or a business. There are special rules and limits for deductions you can claim for a hobby. Here are five tax tips you should know about hobbies:
1. Is it a Business or a Hobby? A key feature of a business is that you do it to make a profit. You often engage in a hobby for sport or recreation, not to make a profit. You should consider nine factors when you determine whether your activity is a hobby.
- Whether you carry on the activity in a businesslike manner.
- Whether the time and effort you put into the activity indicate you intend to make it profitable.
- Whether you depend on income from the activity for your livelihood.
- Whether your losses are due to circumstances beyond your control (or are normal in the startup phase of your type of business).
- Whether you change your methods of operation in an attempt to improve profitability.
- Whether you, or your advisors, have the knowledge needed to carry on the activity as a successful business.
- Whether you were 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 you can expect to make a future profit from the appreciation of the assets used in the activity.
Make sure to base your determination on all the facts and circumstances of your situation. For more about “not-for-profit” rules see Publication 535, Business Expenses.
2. Allowable Hobby Deductions. Within certain limits, you can usually deduct ordinary and necessary hobby expenses. An ordinary expense is one that is common and accepted for the activity. A necessary expense is one that is appropriate for the activity.
3. Limits on Hobby Expenses. Generally, you can only deduct your hobby expenses up to the amount of hobby income. If your hobby expenses are more than your hobby income, you have a loss from the activity. You can’t deduct the loss from your other income.
4. How to Deduct Hobby Expenses. You must itemize deductions on your tax return in order to deduct hobby expenses. Your expenses may fall into three types of deductions, and special rules apply to each type. See of Publication 535 for the rules about how you claim them on Schedule A, Itemized Deductions.
5. Use IRS Free File. Hobby rules can be complex and IRS Free File can make filing your tax return easier. IRS Free File is available until Oct. 15. If you make $58,000 or less, you can use brand-name tax software. If you earn more, you can use Free File Fillable Forms, an electronic version of IRS paper forms. Free File is available only through the IRS.gov website.
Additional IRS Resources:
- Business or Hobby? Answer Has Implications for Deductions
- Publication 525, Taxable and Nontaxable Income
- Publication 529, Miscellaneous Deductions
- Publication 17, Your Federal Income Tax
- IRC Section 183: Activities Not Engaged in For Profit (Audit Technique Guide) — details on the factors to determine “for profit” or “not-for-profit”
The IRS issued “hobby loss” Fact Sheet FS-2007-18, April 16, 2007 (deductions for activities not engaged in for profit). See also IRS Publication 535, Business Expenses. Taxpayers may deduct ordinary (common and accepted in the taxpayer’s trade or business) and necessary (appropriate for the business) expenses for conducting a trade or business. Generally, an activity qualifies as a business if carried on with the reasonable expectation of earning a profit. Taxpayers should consider the following factors:
- Does the time and effort put into the activity indicate an intention to make a profit?
- Does the taxpayer depend on income from the activity?
- If there are losses, are they due to circumstances beyond the taxpayer’s control or did they occur in the start-up phase of the business?
- Has the taxpayer changed methods of operation to improve profitability?
- Does the taxpayer or his/her advisors have the knowledge needed to carry on the activity as a successful business?
- Has the taxpayer made a profit in similar activities in the past?
- Does the activity make a profit in some years?
- Can the taxpayer expect to make a profit in the future from the appreciation of assets used in the activity?
The IRS presumes that an activity is carried on for profit if it makes a profit during at least 3 of the last 5 tax years, including the current year, and at least 2 of the last 7 years for activities consisting primarily of breeding, showing, training or racing horses. Losses from a not for profit activity may not be used to offset other income. The limit on not-for-profit losses applies to individuals, partnerships, estates, trusts, and S corporations, but does not apply to corporations other than S corporations.
Deductions for hobby activities are claimed as itemized deductions on Schedule A (Form 1040). These deductions must be taken in the following order and only to the extent stated in each of 3 categories:
- Deductions that a taxpayer may take for personal as well as business activities, such as home mortgage interest and taxes, may be taken in full.
- Deductions that don’t result in an adjustment to basis, such as advertising, insurance premiums and wages, may be taken next, to the extent gross income for the activity is more than the deductions from the first category.
- Business deductions that reduce the basis of property, such as depreciation and amortization, are taken last, but only to the extent gross income for the activity is more than the deductions taken in the first two categories.