If the IRS believes you operate a hobby and not a for profit business, you could owe a lot in taxes, penalties, and interest. Failing to understand the hobby loss rules can potentially be a very costly mistake.
Internal Revenue Code (IRC) § 183, Activities Not Engaged in for Profit (The “Hobby Loss Rules”)
If you have a job and make money from a hobby, you are mot alone. Millions of people enjoy hobbies as a source of income. Understanding how the Internal Revenue Service (“IRS”) views these activities is extremely important for tax planning purposes. This article provides 5 tax tips relating to the hobby loss rules under IRC § 183, including how to report hobby income and hobby expenses.
What is a Hobby?
The IRS has established a non-exclusive list of activities that implicate the hobby loss rules. Some examples include fishing, horse racing, horse breeding, farming, motorcross racing, auto racing, craft sales, bowling, stamp collecting, dog breeding, yacht charter, artists, gambling, bowling, direct sales, photography, writing, entertainers, and airplane charter rentals.
You Must Report Hobby Income
The general rule is that you must report the income you earn from a hobby on your tax return. The rules for how you report hobby income and hobby expenses depend on whether the activity is considered a hobby or a business under the tax rules and regulations. If you determine that your activity is a hobby, there are special rules and limits for claiming deductions under the hobby loss rules.
5 Tax Tips on Hobby Loss Rules
- Business or a Hobby? Is your goal with your activity to make a profit? Businesses operate to make a profit. If you engage in your activity for fun or recreation, it is not a business because your goal is not to make a profit. The IRS has set forth nine factors to consider whether your activity is for profit.
- Allowable Hobby Deductions. The tax laws allow you to deduct ordinary and necessary hobby expenses, subject to certain limits and within reason. Ordinary and necessary are defined terms generally meaning common, accepted, and appropriate for the activity.
- Hobby Expense Limits. The general rule is that you can only deduct hobby expenses up to the amount of hobby income. But, if your hobby expenses are more than your hobby income, you will have a loss from the activity. Under the hobby loss rules, you cannot deduct the hobby losses from your other income. Most people who get into trouble with the IRS typically find themselves there because of this issue.
- How to Deduct Hobby Expenses. You deduct hobby expenses on Schedule A of your Form 1040 as an itemized expense. You do not deduct them on Schedule C as you would a business expense.
- Use IRS Free File. The IRS has offered free file to do your federal income tax returns to report your hobby income and expenses. Free File is available until Oct. 15.
Porter Law Office, LLC is a boutique tax firm that assists individuals and businesses with a variety of tax issues, including advising on the often misunderstood, and complex hobby loss rules. If you are looking to find a lawyer, contact Columbus Ohio tax lawyer for a free consultation to discuss how the hobby loss rules may impact you.
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Contact Porter Law Office, LLC Today
Porter Law Office, LLC is a boutique firm that assists individuals and businesses with tax planning. If you are engaged in a hobby, you must fully understand the hobby loss rules. Otherwise, you may find yourself serviced with an IRS audit notice. If you think your hobby has become a business, contact an experienced Columbus Ohio tax lawyer to discuss your options. Columbus Ohio tax attorney Matthew R. Porter, J.D., LL.M. has the skills you need to properly structure your tax transaction. Contact Mr. Porter today for a free consultation to discuss your case.
Helpful IRS Hobby Loss Resources
- Business or Hobby? Answer Has Implications for Deductions
- Publication 525, Taxable and Nontaxable Income
- Publication 529, Miscellaneous Deductions
- Publication 17, Your Federal Income Tax
- IRC Section 183: Activities Not Engaged in For Profit (Audit Technique Guide) – details on the factors to determine ‘for profit’ or ‘not-for-profit’, very in depth!