Anyone who is running a business, generally, does so mainly for earning profits. Well, one may be running it ‘only’ for earning profits. And rightfully so!
Such an individual would well be aware that he is required under the state law to do proper accounting for tax purposes. He is required to maintain proper records of all his financial transactions, be it investments or expenses or income from any source whatsoever during the conduct of his business. State has laid down proper and detailed rules for computing income from any ‘For-Profit’ business. Clear cut rules are also there for various deductions allowed for specified expenses incurred during the course of your business. Tax liability is calculated after accounting for all such incomes and expenses as allowed under the law. There is generally no ambiguity in this regard.
On the other hand, when it comes to pursuing of hobbies and accounting, if any, for any income from such hobbies and paying tax on such income, clarity is often missing. You would perhaps know some people who have a large collection of paintings made by them which they now want to sell for one reason or the other. But they are apprehensive about the tax implications once they sell their paintings and derive an income out of this activity, which has hitherto been a ‘safe’ hobby only.
Well, even people such as above need not worry one bit about accounting and their tax liability. The rules pertaining to hobbies and any income from one’s hobbies are crystal clear. Your pastime or hobby could be painting, photography, coin collection, craft making or even horse breeding. It usually costs money to pursue your hobby and in certain cases, your hobbies could also make you money.
It is very important to note here that if your hobby fetches you any income, you are required to report such income on your Federal tax return. You must also ascertain whether your activity is classified as a hobby or a business.
Any activity which you engage in for sport or recreation and not for making a profit is classified as a hobby, even if it generates an occasional income.
The IRS has laid down 9 factors to be considered for establishing if any activity is a business for tax purposes. Further, any activity is deemed to be a business if it makes a profit during 3 or more of the last 5 tax years including the current year or during 2 or more of the last 7 years if it comprised of breeding, training, showing or racing of horses.
Rules pertaining to tax deductions for expenses on hobbies, after proper accounting, are different from those pertaining to business expenses.
