Are you a part of the growing gig economy? Do you run a side hustle? Wondering if it’s a business or a hobby? Are you reading this and wondering why you should care?
For the purpose of taxes these activities are more commonly referred sideline activities. Think Direct Sellers (i.e. Tupperware, Mary Kay, Pampered Chef, etc) or Uber and Doordash.
The tax benefits of being able to write off expenses for these endeavors can reap tremendous rewards.
To begin ask yourself this; From this sideline activity, are you claiming tax losses on your Form 1040? Will the IRS consider your sideline a business and allow your loss deductions or is it simply a hobby?
The IRS likes to claim that money-losing sideline activities are hobbies rather than businesses. The federal income tax rules for hobbies have been anti-taxpayer for years, and now an unfavorable change enacted in the Tax Cuts and Jobs Act (TCJA) made things even worse for 2018-2025.
Here’s the test:
If you can show a profit motive for your now-money-losing sideline activity, you can classify that activity as a business for tax purposes and deduct the losses. Are you doing it to make money?
- Record Keeping is Key: Conducting the activity in a business-like manner by keeping good records and searching for profit-making strategies. (Did anyone say bookkeeping?!?)
- Constantly Learning: Having expertise in the activity or hiring advisors who do. (Sideline activities provide an excellent reason to reinvest in yourself by researching, reading and attending seminars to not only re-energize you but to increase your knowledge base)
- Time Spent: By spending enough time to justify the notion that the activity is a business and not just a hobby. (This is especially important for Real Estate Agents who must meet the annual 750 hour minimum)
- Will your initial investment produce positive returns….eventually: Expectation of asset appreciation: this is why the IRS will almost never claim that owning rental real estate is a hobby, even when tax losses are incurred year after year.
- Success in other ventures, which indicates that you have business acumen.
- The history and magnitude of income and losses from the activity: occasional large profits hold more weight than more frequent small profits, and losses caused by unusual events or just plain bad luck are more justifiable than ongoing losses that only a hobbyist would be willing to accept.
- Your financial status: Wealthy individuals may be able to afford ongoing losses (which may indicate a hobby), while ordinary individuals are usually trying to make a buck (which indicates a business).
- Elements of personal enjoyment: breeding racehorses is lots more fun than draining septic tanks, so the IRS is far more likely to claim the former is a hobby if losses start showing up on your tax returns.
Remember the key component is in the intention, can you (if questioned) prove that your intention was to make a profit?