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:
The PROs
- 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 CONs
- 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
