Jewelry maker, potter, blogger, selling wine at parties, have your own Etsy store? Are these endeavors businesses or hobbies? And who cares?
The IRS cares.
No matter where it comes from, if you earn income, the IRS wants its fair share. But how that is calculated depends on if it is a business or a hobby. Businesses are able to easily claim expenses and lower their taxes, but they owe self-employment taxes on the net income. If there is a loss this can offset other earned income.
Hobbies, however, do not have to pay self-employment taxes but any losses can not be used to decrease your overall income. There is a way to deduct expenses in certain cases, but only up to the amount of the hobby income. This is going away with the new tax laws but is still in place for completing your 2017 taxes.
It is very important that you classify your side job appropriately. If the IRS decides you did it wrong they could go back and assess back taxes and possibly penalties, including wage garnishment!
So how do you figure it out? They have a set of guidelines to help you decide. Like many tax documents it can be confusing so it helps to have a pro like me on your side sometimes. In essence, if you treat it like a business, it’s a business. They want to see that it is designed and run to make money, even if you are unsuccessful. Posting a profit three out of five years is a good sign. Things like having a separate bank account, advertising, keeping good books, making changes based on past performance, demonstrate that this is a business designed to turn a profit.
So…does your hobby qualify as a business under IRS law?