Who knew you had a green thumb? You started gardening as a way to de-stress. Now, you’re growing exotic orchids in your family room. It was a pricey hobby until you learned how to propagate orchids and started selling them to other hobbyists. And now you’re thinking you might be able to turn growing orchids into an income source — and your hobby into a business.
Once people start making money from their hobbies, they frequently start to deduct all of their hobby-related expenses. At this point, the IRS can become very interested in the nature of the taxpayer’s hobby/business. There are certain tax guidelines to keep in mind.
If you earn income from your hobby, you generally can deduct bona fide hobby-related expenses up to the amount of the annual income your hobby generates. You must itemize to claim the deduction. Hobby expenses fall into the “miscellaneous” category, so they are grouped with any other miscellaneous expenses you have, and only the amount exceeding 2% of your adjusted gross income is deductible.
These restrictions don’t apply to business expenses. If you operate an active business, your business-related expenses generally will be deductible, even if they exceed your business income (limitations apply).
Passing the Test
The IRS won’t just take your word for it. It has a set of guidelines to determine whether a hobby qualifies as a business. First and foremost, you must be pursuing the activity with the goal of making a profit. If you’ve made a profit in three of the last five years (two of the last seven if your activity is horse breeding, showing, or racing), the IRS assumes you had a profit motive.
If you don’t meet the profit criteria, here are a few of the other questions the IRS may ask:
- Do you keep accurate books and separate your venture’s finances from your personal finances?
- Do you spend significant time and effort carrying out the venture?
- Does the activity involve a significant element of personal pleasure or recreation?
- Don’t deal with tax issues on your own. Call us right now to find out how we can provide you with the answers you need.
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