Hobby or Business?

In the United States, especially with the current economic situation, there are many people who have branched out to side-jobs and performing gigs with their arrays of skills. When it comes time for federal tax reports, though, what happens? This guide will tell you whether what you are doing should be reported as a hobby or if you will need to take the plunge into sole proprietorship.

Fun or Profit?
Why are you doing this? Generally, if you are just in it for fun, even if you are making money doing it, what you are doing is a hobby, rather than a business. If you begin taking it seriously, cut back on hours, fund a major purchase, or otherwise get into profit analysis, you will probably need to get a business license and organize as a sole proprietorship (or other type of business).

How much profit?
If you are truly depending on income from the hobby, rather than just using it to relax or amuse yourself, you are definitely running a business. If you are analyzing supplies, changing prices on sales, or otherwise working on marketing or business plans, you are running a business.

What do you know?
If you have a lot of experience in the field and your hobby is beginning to pay for flat-screen televisions, it is more than a hobby according to the IRS. However, some people do not have the knowledge necessary to be reasonably expected to run a profitable business. In this case, you may need to contact the IRS for help, or speak with a representative at your local Small Business Development Center.

What is your experience?
If you have made a profit with your hobby in the past, you are usually considered a freelancer, and will need to file as a business. There are exceptions, but generally, if you have a profitable hobby for three out of five tax years, your activity qualifies as a business.

Appreciation
If you expect to make a profit from appreciation of assets in the coming years, you are definitely running a business.

Rule of Thumb
The line between hobby and business usually involves both intent and extremity. You may be intending to make a profit, but if you only earn $20 in a year, you can get by with calling it a hobby. Your intent may be to have fun, but if you make $5,000 per month doing it, you will be considered to be running a business. If you fall into a gray area, please consult with the IRS or a Small Business Development Center in your area.

What now?
If you have determined that you are running a business, you will need to get a state tax identification number, get a business license, organize as a sole proprietorship (or other type of business; there are advantages and disadvantages for all, but sole proprietorship is probably simplest here), and possibly get an employer identification number from the IRS, among other things. Don't walk the line between hobby and business for long, or you may find you owe a lot of money on taxes in a few years, should you be audited.