Tax accounting for hobby income and expenses

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.

1. 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.
2. 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.
3. If total expenses exceed income then depreciation is the first expense to be disallowed.
4. 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?“