If you have an active hobby then you might find that you make some money at it. But it is important to recognize that the IRS makes a distinction between businesses run for profit and those that are hobbies without a profit motive. This post summarizes the four key differences in tax accounting between the two.
- Hobby businesses cannot be used the generate losses that reduce other taxable income. For example, you have a $60,000 salary and your hobby business loses a net of $10,000 per year. You don’t get to net the two and report your taxable income as $50,000.
- You are always allowed to deduct expenses up to the amount you earn in the hobby business. For example, the hobby business generated $15,000 gross income but you spent $25,000. You get to deduct $15,000 of the $25,000 expenses so that your net hobby business income is $0.
- If total expenses exceed income then depreciation is the first expense to be disallowed.
- Expenses are deducted on IRS 1040 Schedule A, not the Schedule C as used for for-profit businesses.
This post does not cover the factors that IRS uses to determine whether an activity is a business or a nonprofit activity. See “Is Your Hobby a For-Profit Endeavor?“