If you have a hobby on which you spend money, can you claim your expenses as tax deductions? The simple answer is “no”. But there are circumstances in which you CAN claim your hobby expenses as tax deductions. The bottom line is if your hobby is deemed to be a business, then you can claim its expenses as tax deductions.
In any business, there are two categories of expenses that the IRS recognizes. They are ordinary expenses and necessary expenses. By definition, ordinary expenses are those that are common and accepted in your trade whereas necessary expenses are those that are appropriate for the business. A business, on the other hand, is an activity that is carried out for the purpose of profit. So a hobby that is carried out as a business is termed as a “hobby business”.
Hobby businesses are usually run from home and are often based on semi-recreational activities that you are fond of. Some examples are wedding photography, furniture refurbishing, a music band for hire etc. Being able to claim expenses from these activities against your taxes is the benefit of having a hobby business.
Most people with hobby businesses have steady jobs. Even if you incur a loss in your hobby business, you should declare it as the loss will not only reduce your overall taxes but may even drop you down into a lower tax bracket.
The difficult part is proving your hobby is a hobby business. If you consistently deduct your hobby business losses from your other income year after year, you'll probably attract the attention of the IRS. Make sure that the IRS will consider your hobby a real business before you start claiming deductions for the expenses.
So how does the IRS determine if your hobby is a business? They look for a few criteria
• The time and effort put into the hobby shows an intention to make a profit
• The taxpayer depends on income from the hobby as livelihood
• The causes for losses in the hobby – are they due to circumstances beyond the taxpayer’s control or did they occur in the start-up phase of the business?
• The amount of knowledge/expertise/experience needed to carry on the hobby as a successful business
• Whether any profit has been made from similar activities in the past
• Whether any profit has been made over the years
Here’s one popular way you can prove your hobby is a business – show a profit 3 times over 5 consecutive years. This means you should not show a loss in your hobby for 3 straight years. You may (and should) use other forms of “evidence” to show your hobby is a business, such as business cards, up-to-date financial records, a separate business bank account, a business license and permit, advertising expenses etc.