We should all be so lucky to make a living doing something we love. That’s why a lot of people decide to convert the time and money they spend on their hobby into a new business!
The idea of being able to deduct qualified business expenses certainly has its appeal. But it’s important to understand how each type of activity functions. The IRS has specific criteria for the definition of what a business actually is—and how it’s different than a hobby. Because if you don’t understand those basics, there might be major tax errors and headaches down the line.
The Difference Between a Business and a Hobby
Whether it’s making ceramics, teaching swimming lessons, or doing light handy work—there are plenty of ways that people can make a little extra money on the side. And have it actually be fun! The catch, though, is to figure out where your work actually belongs in the eyes of the IRS. Then you’ll be able to determine the best route for claiming your tax benefits.
For starters, you need to consider the “effort and income” of your particular interest. Do you depend on the income you’re getting? Are you selling those products and services during your free time, or does it take up a good portion of your week? Basically, be realistic about where you’re making your money. One definition for running a business is that you’ve devoted a significant amount of time and effort into your work because that’s where the bulk of your money comes from.
Another thing to ask yourself is whether your “business” expenses are absolutely necessary. In order to deduct certain purchases or investments as true business expenses, you need to be able to show that they’re an ordinary yet crucial part of your operation. This also goes hand in hand with how you keep your bank records. You’ll want a separate account and organized profit and loss statement if you want to go the route of starting a business. That way, you’ll be in a better position to present a clear history of your profits.
Ready to Build Your Business?
When it seems like you’re right on the border between having a hobby and running a business, definitely take the time to run the numbers. It might make a lot of sense to take the plunge and start a business. So let us help you figure out the right next steps! There are a lot of ways to save money based on how you file your taxes, especially when you meet the requirements of the IRS business definition.
At NSO and Company, we love supporting small business owners. If you’re starting to explore your options, we’d be more than happy to be a sounding board. Give us a call at (317) 588-3131 so we can schedule a formal time to talk!