Understanding the Difference: Hobby vs. Business and Tax Implications

by | Jun 7, 2024 | Blogs, Business Strategy, Tax Tips

Issue Number: Tax Tip 2024-55

In the world of side hustles, distinguishing between a hobby and a business is crucial, especially when it comes to tax obligations. At Business Untangled, we believe in empowering individuals with the knowledge they need to navigate the complexities of taxation and financial management. Let’s delve into what people need to know if they have a side hustle and how it can impact their tax filings.

 

Hobbies and businesses are distinct entities in the eyes of the IRS. The differentiating factor lies in their primary purpose: businesses operate with the intention of making a profit, while hobbies are pursued for pleasure or recreation. However, the lines between the two can sometimes blur, leading to confusion when it comes to tax responsibilities.

 

One key consideration for individuals with side hustles is the receipt of payments through payment apps for goods and services. If these transactions occur throughout the year, individuals may receive an IRS Form 1099-K, indicating taxable income that must be reported on federal tax returns. It’s essential to understand the tax implications of these payments, regardless of whether the activity is deemed a hobby or a business.

 

When determining whether a project qualifies as a hobby or a business, individuals should assess various factors that contribute to this classification. Profitability, intent to make a profit, financial dependence on the activity, and adherence to business practices are all critical aspects to consider. By evaluating these questions, individuals can gain clarity on the nature of their side hustle and its tax implications.

Here are some key questions to help individuals discern between a hobby and a business:

1. Does the time and effort invested in the activity demonstrate an intent to generate profit?

2. Is the activity consistently profitable, and to what extent?

3. Are there expectations of future profits from the assets used in the activity?

4. Does the individual rely on the activity’s income for livelihood?

5. Are losses incurred due to uncontrollable circumstances or typical for a startup phase?

6. Is there a proactive approach to improving profitability through operational changes?

7. Is the activity conducted in a businesslike manner with meticulous recordkeeping?

At Business Untangled, we emphasize the importance of maintaining accurate and comprehensive records, regardless of whether individuals have a hobby or run a business. Sound recordkeeping practices throughout the year can streamline the tax filing process and ensure compliance with IRS regulations.

By understanding the distinctions between hobbies and businesses and the associated tax considerations, individuals can make informed decisions about their side hustles and effectively manage their financial responsibilities. At Business Untangled, we are here to support individuals in navigating the nuances of taxation and achieving financial clarity in their entrepreneurial endeavors. Let’s untangle the complexities together and pave the way for financial success!

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