Hobby income is income, too. And just like any other income, the IRS wants its cut.
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How much can you earn from a hobby before paying tax?
Your first dollar of income from your hobby should go on the other income line of your income tax return. There is no minimum amount of hobby income to be taxed on it. However, you may not have to pay tax if your total income isn’t high enough for you to owe taxes.
Do you always need to file a tax return for hobby income?
The usual tax filing thresholds apply to whether you need to declare hobby income. If your total income, including hobby income, is above the threshold, you need to file a Form 1040.
The threshold is usually equal to the standard deduction. In 2019, that’s $12,200 for single filers and $24,400 for joint filers. Note that there may be other reasons you need to file a tax return if your income was below those amounts.
What’s the tax rate on hobby income?
Hobby income is ordinary income subject to your normal income tax rate based on your tax bracket. That’s 10%, 12%, 22%, 24%, 32%, 35%, or 37%.
Do you pay self-employment taxes on hobby income?
Hobby income is not earned income. Social Security and Medicare taxes only apply to earned income.
Do you need to declare hobby income on state taxes?
State tax rules often follow the IRS but they may vary. If your state has an income tax, you’ll need to check the specific rules for your state.
Can you deduct hobby expenses on your tax return?
Since 2018, there are no deductions for hobby expenses. You must include all hobby income in your taxable income even if your hobby expenses were greater than your hobby income.
For tax years through 2017 before the Tax Cuts and Jobs Act, you could only deduct hobby expenses up to your hobby income. That allowed you to offset what you made but not to get a deduction against other income. This was as a miscellaneous itemized deduction subject to a floor of 2% of your adjusted gross income.
How does the IRS decide if you’re a business versus a hobby?
The general test for whether you’re a business or a hobby is called the hobby loss rule. The hobby loss rule says that if you lose money in three out of five years, you’re presumed to be a hobby. If you make money in three out of five years, you’re presumed to be a business.
Are there exceptions to the hobby loss rule?
The hobby loss rule is just a presumption. You can safely follow it in most cases. You can also take the opposite position that you’re a hobby when you’re presumed to be a business, or vice versa. The IRS can also do the same, although they will usually follow the hobby loss rule.
One example of an exception is where you just started a business. Even some of the big tech companies like Amazon took years to make a profit. If you can demonstrate that you’re attempting to grow a profitable business, you can avoid the IRS saying you’re a hobby.
How do you show that you’re a business or a hobby?
Other than whether you’re making a profit, the IRS looks at a number of factors to decide if you’re a business or a hobby. These include whether:
- You depend on the income you receive
- You’re doing it for fun
- Your profits are in line with the time and effort you’re spending on the activity
- You keep books and records like a business
- You’re trying to improve your profits
Can you get audited over whether you’re a business or hobby?
The IRS does a lot of business versus hobby audits. One of the reasons for the current rules was wealthy racehorse owners would spend far more than their winnings on their racing hobby but declare it as a business to get favorable tax treatment and take a loss against their other income.
- If you’re a legitimate small business that’s losing money early on, there’s a good chance you could get audited, but that in no way means you will lose. The IRS will just want to see how you’re operating as a business and trying to grow into profitability.
- If you think you’ve found a good way to turn your hobby into a tax deduction, you should probably think twice. The IRS may add a penalty and interest if they find you misclassified you’re hobby as a business.
- If you have what could be a legitimate business but are taking excessive deductions, you could get turned into a hobby. A common example of this is sports officials who try to do some games during a family vacation and then try to claim all of their travel expenses as a business expense. Again, you need to show how what you’re doing is designed for efficient profit.
Can you switch between a business and a hobby?
It is possible for a hobby to turn into a business or a business to turn into a hobby. Maybe people liked your art so much you started regularly selling it at craft fairs. Or you realized selling your art was no fun and not profitable enough and went back to doing it as a hobby.
You have to consider each year whether you’re a business or a hobby. If the IRS thinks you should have changed how you classify your activity, they might audit you. Similarly, if you haven’t really changed what you’re doing but are trying to game your tax situation, the IRS might audit that. You have to honestly assess your situation and keep records of everything.
What about hobby selling?
There is no such thing as hobby selling under the tax code. Hobby selling usually refers to buying and selling things as part of a hobby. It would follow the above rules.
If all you’re doing is buying and selling while making a steady income, you’re probably a business. If you have collectibles that you display and enjoy but occasionally sell some to make space or raise money to buy more, it’s likely a hobby.
Can you contribute to a retirement account based on hobby income?
Hobby income is not earned income. Retirement accounts only allow contributions from earned income.
If you do have earned income, there is nothing stopping you from putting the extra money into a retirement account, but your contribution limits would be based solely on your earned income.
Hobby income does count towards the AGI limit for a Roth or traditional IRA.
Are there any benefits of being a business instead of a hobby?
It could actually be better to be a business instead of a hobby even if you’re paying taxes on your profits. First, you’re getting your deductions back, so you may pay less in total taxes. Second, your income will count towards your Social Security earnings record and increase your benefits in retirement. Finally, you may be eligible to contribute additional money into a self-employed retirement account.
Remember, this can all vary based on your tax situation. Be sure to seek out personalized tax advice from a tax preparation expert if you aren’t sure what to do.