Definition of a hobby: a pursuit outside one’s regular occupation engaged in especially for relaxation
Organizing weddings is just a hobby of hers.
Her hobbies include gardening and people-watching.
Truth is… thousands of people, if not more, have hobbies that have turned into income-generating sources (businesses) and vice-versa. It could be anything from gardening, flower arranging, baking, cooking, or even organizing weddings.
A hobby is mainly done during your spare time for pleasure or recreation.
The Rule of Thumb
If a business reports a net profit in at least THREE out of five years, the IRS presumes that it’s a for-profit business. If a business reports a net loss in more than two out of five years, it’s presumed to be a not-for-profit hobby.
These are the main benefits you receive when you take on a hobby:
- You can do it at your own leisure, pace, time, or when people contact you.
- You receive personal happiness, fun, and satisfaction from the activity.
- You are able to either gift or sell your work for the cost of materials.
- You are not obligated to maintain records or reports similar to those of a business.
What is a business?
However, with all things considered, when exactly does your hobby turn into a business?
From the point of view of the Internal Revenue Service (IRS), a hobby becomes a business when you start earning MONEY. The crucial differences to keep in mind is the insurance, legal, and most importantly, your tax responsibilities when considering whether your hobby is a business or not.
Here are some factors to remember to determine if you are running a business:
- Registered your business name
- Identified your business structure
- Obtained an Employer Identification Number (EIN)
- Have the intent of making profits / Generating profits
- Size and scale of activity is similar to businesses in the same industry
- Organized daily operations (business records, bank account, premises, licenses, etc.)
Identifying if an activity is related to a hobby or a business
The IRS has provided these key points in identifying whether an activity is a hobby or a business engaged in making a profit:
- Whether you carry on the activity in a businesslike manner and maintain complete and accurate books and records.
- Whether the time and effort you put into the activity indicate you intend to make it profitable.
- Whether you depend on income from the activity for your livelihood.
- Whether your losses are due to circumstances beyond your control (or are normal in the startup phase of your type of business).
- Whether you change your methods of operation in an attempt to improve profitability.
- Whether you or your advisors have the knowledge needed to carry on the activity as a successful business.
- Whether you were successful in making a profit in similar activities in the past.
- Whether the activity makes a profit in some years and how much profit it makes.
- Whether you can expect to make a future profit from the appreciation of the assets used in the activity.
Pros and Cons
Of course, letting your hobby grow into a business has its own perks and disadvantages. See the shortlist below on what you can expect:
- You can start right away because you already have the skill
- You’ll be more driven, passionate and happier with your work
- You’ll be able to take advantage of your existing contacts
- You should already have all the tools needed
- You know the market like the back of your hand
- The business may suck out all the fun and passion from what you love
- No viable market for your specific niche
- More demand means more production and more manpower
- Taxes may tend to be higher side
Still, confused on whether you’d like to run a business or just keep your activity within the confines of a hobby? You can reach out to the IRS or enlist the services of a consultant to get more advice on what your next steps will be. We, at True Client Pro, will continue to help you every step of the way. Make things easier by organizing your activities and contacts with our intuitive and easy to use CRM. Feel free to reach out and contact us should you have any further questions!