Turning Your Hobby Into a Business
July 26, 2021
You’ve loved dogs all your life so you decide to start a dog training business. Turning your hobby into a business can provide tax benefits if you do it right. But it can create a big tax headache if you do it wrong.
One of the main benefits of turning your hobby into a business is that you can deduct all your qualified business expenses, even if it results in a loss. However, if you don’t properly transition your hobby into a business in the eyes of the IRS, you could be in line for an audit. The agency uses several criteria to distinguish whether an activity is a hobby or a business. Check the chart below to see how your activity measures up.
| BUSINESS | VS. | HOBBY |
| You have a reasonable expectation of making a profit. | Profit motive | You may sell occasionally, but making money isn’t your main goal. |
| You invest significant personal time and effort. You depend on the resulting income. | Effort and income | It’s something you do in your free time; you make the bulk of your money elsewhere. |
| Your expenses are ordinary and necessary to run your business. | Reasonable expenses | Your expenses are driven by your personal preferences and not strictly necessary. |
| You have a track record in this industry, and/or a history of making profits. | Background | You don’t have professional training in the field and have rarely or never turned a profit. |
| You have multiple cutomers or professional clients. | Customers | Your customers are mainly relatives and friends. |
| You keep professional records, inclduing a separat checkbook and balance sheet; you have business cards, stationery and a branded business website. | Professionalism | You don’t keep strict professional records of your activities; you don’t have a formal business website or business cards. |
The Business Vs. Hobby Test
If your dog training business (or any other activity) falls under any of the hobby categories on the right side of the chart, consider what you can do to meet the business-like criteria on the left side. The more your activity resembles the left side, the less likely you are to be challenged by the IRS.
On the other hand, if you determine that you’re really engaged in a hobby, there are still some tax benefits to be had. You can treat hobby expenses as a miscellaneous itemized deduction on a tax return, but generally not more than hobby income. They can be used to reduce taxable income if they and other miscellaneous expenses surpass 2 percent of your adjusted gross income.
If you need help to ensure you meet the IRS’s criteria for businesslike activity, reach out to schedule an appointment.