When you incorrectly claim your favorite hobby as a business, it's like waving a red flag that says "Audit Me!" to the IRS. However, there are tax benefits if you can correctly categorize your activity as a business.
Why does hobby versus business activity matter?
Chiefly, you're allowed to reduce your taxable income by the amount of your qualified business expenses, even if your business activity results in a loss.
On the other hand, you cannot deduct losses from hobby activities. Hobby expenses are treated as miscellaneous itemized deductions and don't reduce taxable income until they (and other miscellaneous expenses) surpass 2 percent of your adjusted gross income.
Here are some tips to determine whether you can define your activity as a business. These are common characteristics of a business:
The IRS will consider all these factors to make a broad determination whether you operate your activity in a business-like manner. If your business doesn't fit with the guidelines above, it might be a hobby. Each case is unique, and you should seek out professional advice on making this determination. If you need help ensuring you meet these criteria, reach out to schedule an appointment.