Introduction
Small businesses, known as "hobby businesses," are typically run out of the owner's home (since renting an office would be prohibitively expensive) and center around semi-recreational pursuits that are meaningful to the owner. A hobby business can be any of a wide variety of different things. Examples include a gem-making workshop in the basement, a jazz band that plays at weddings, and antique restoration service. A person's hobby or side business is typically more of a labor of love than a steady revenue stream. This is often the case when the business owner or freelancer also has another source of income (such as a 9-to-5 job or a working spouse) that effectively underwrites the microbusiness.
Hobby Income and Expenses
The IRS no longer permits hobbyists to deduct hobby-related expenses from hobby-related income beginning in 2018. Earnings from a side gig must be reported in full; deductions for hobby-related costs are not allowed. If you itemize your deductions and your adjusted gross income is less than $250,000, you can deduct expenses related to your hobby up to that amount for tax years before 2018. In addition, your hobby income should not be less than or equal to the amount you claim as expenses.
That is to say; your pastime must not result in a negative cash flow. If you knit sweaters and spent $300 on yarn and other supplies but only made $150 on the sale of one sweater, you can deduct only $150 in costs ($300 minus $150). However, you can use the full amount if you spent $300 on your knitting hobby and made $300 from selling two sweaters. "Ordinary" and "necessary" expenses are the types of expenditures that can be deducted.
Allowable Hobby Deductions
The biggest problem with writing off hobby costs is that you can only do so much. Until you turn a profit from your pastime, you can't write off any of the money you put into it. To be deductible, hobby costs must exceed 2% of AGI along with all other miscellaneous expenses listed on Schedule A. Turning your hobby into a business could be beneficial financially if you find that you are making money from it regularly. You might be underestimating how easy it is. Income from a sole proprietorship is reported on Form 1040, and a greater variety of deductions may be claimed.
Tax Filing May Be More Complicated
Turning your hobby into a business might be the way to go if you want to reduce your tax burden. Maintain accurate financial records for everything you spend on the business, including a summary of gains and losses, purchase invoices, and other proof of payment.
If you don't have the right paperwork, you won't be able to deduct any of your business expenses. In addition, failing to report your income accurately could result in either overpayment or underpayment of taxes. The Internal Revenue Service (IRS) may conduct an audit of your tax return if they suspect something is amiss. You could face a hefty tax bill if the IRS determines that you lied about your eligibility for tax deductions.
When Your Hobby Is a Business
What the Internal Revenue Service calls "a pastime" is any activity engaged for its own sake rather than to make money. That's because you'd do it whether or not it ever made you money. If you shift your thinking, the government will treat your income more favorably when filing your taxes. Suppose you file as a sole proprietor, independent contractor, or have some other business structure. In that case, your net taxable income will be calculated using Schedule C, where you can deduct expenses related to your hobby.
Using this method, you can avoid the 2% rule applied to tax returns filed before 2018. You can use Schedule C to report a loss against other sources of income. You could deduct $1,500 from your regular income to cover the difference between the cost of the puppies ($6,000) and your total monthly expenses ($7,500). Simply engaging in an activity, you enjoy could lower your yearly tax burden.
Conclusion
Tax breaks for hobby costs are no longer deductible as of 2018, thanks to the Tax Cuts and Jobs Act. To deduct any costs associated with running your business, you must prove that it is a business and not a personal endeavor. The IRS considers things like whether or not you turned a profit for three of the past five years, whether or not you kept thorough financial records, whether or not you have sufficient expertise in the field, and whether or not you devote substantial time to it. You can reduce your business's taxable income by the number of your allowable deductions, and you can use a loss from one year to cancel out profits from another.
