January is a time of New Year’s resolutions, fresh ideas, and a fresh start. For many, it means a time of pursuing new small-business endeavors. Fayette County has a thriving economy and is a great place to start a “side-hustle” or turn your passion into something that produces a profit. If 2020 is the year for you to dive into a new endeavor, it’s important to know whether the IRS will treat your new activity as a hobby or a real business.
While you must report income earned from both hobbies and businesses, there’s a big difference when it comes to claiming deductions.
With a hobby, you report and pay tax on 100% of your revenue. However, with the recently passed Tax Cuts and Jobs Act, for tax years 2018-2025, if the IRS determines you are indulging in a hobby, you can no longer deduct any hobby-related expenses. Ouch.
On the other hand, a qualified business can deduct expenses, so long as they are “ordinary and necessary,” even if it results in a loss.
Due to the new tax laws, qualifying as a business rather than a hobby will usually be favorable.
So how does your activity qualify as a business for IRS purposes? The IRS knows this is a bit of a gray area, so they have given guidelines to help us make this determination. The primary determining factor is whether you’re making a profit or have the intent to make a profit. Other factors such as having a separate business bank account, keeping well-maintained books, and maintaining local business licenses and permits, are all solid indicators that your activity is a legitimate business.
If you’re unsure if your new endeavor will qualify as a business rather than a hobby, visit a CPA or tax specialist to discuss your specific circumstances.
Lacey Harnar is a Certified Public Accountant meeting the accounting needs of individuals and small businesses around Atlanta... and everywhere else.