When your hobby takes a leap: Turning passion into a business

Editor’s note: The opinions expressed in this commentary are the author’s alone. Latasha Randle is a Strategy & Small Business Program Manager at H&R Block, a company founded and headquartered in downtown Kansas City. 

Many of us have hobbies that spark joy and help us unwind from the stresses of everyday life. From gardening, painting, knitting, and cooking, hobbies reflect our inner passions and interests. But what happens when your hobby evolves into something more?

When the line between leisure and work blurs, you may wonder whether to turn your beloved pastime into a full-fledged business.

How to differentiate a hobby vs. business

Let’s explore different considerations so you can make the most of your hobby or entrepreneurial journey.

Latasha Randle, Strategy and Small Business Program Manager at Block Advisors by H&R Block

Funding considerations

One indicator that your pastime is no longer a hobby is you’re seeking larger amounts of financial support from family, friends, or banks. If your financial backing is starting to ask, “What’s in it for me?” then you might consider becoming a business and tapping into other funding resources, such as small business grants that are tailored to your type of business. For example, if you’re a 51% woman-owned business, Fund Her Future, H&R Block’s Small Business Grant for Women, provides a total of $100,000 in grants and essential small business services to some of the fastest-growing organizations (read my previous Startland News post for details). 

Profitability considerations

Still not sure? The first thing to consider is whether you generated a profit in three out of the last five years. If you have your activity is presumed to be a business by the IRS. If you haven’t, the following questions generally help answer if the activity is a business or a hobby:

1. Is the activity conducted in a professional manner? For instance, do you perform bookkeeping activities? Or is it more for general enjoyment and relaxation?
2. Does your effort in the activity indicate you intend to make it profitable?
3. Do you have sufficient knowledge and skills for the activity?
4. Do you depend on the income from the activity?
5. Have you changed your methods of operation to improve profitability?
6. Have you made a profit performing related activities in the past?
7. Do you currently make a profit?
8. Do you expect to profit in the future or appreciate assets used for the activity?

In short, hobbies are pursued for personal enjoyment, while businesses engage in activities for profit. If you realize you’re operating a business, there are various tax and financial compliance implications to consider.

The difference between business and hobby income

The IRS has specific criteria to differentiate the two as mentioned above. Let’s explore the nuances.

Business income deduction rules

A small business can offset its income with ordinary and necessary expenses. To do this, you deduct operating expenses against operating revenue. If you have a loss, you can deduct the loss from other types of income and even carry the loss forward to offset income in future tax years. This is known as a net operating loss or NOL for short.

Be mindful that business expenses are deductible only for activities performed as a business. The IRS pays attention to businesses with several years’ worth of losses, as it might be a business vs. hobby. This could result in the disallowance of business deductions, limiting the amount of losses you can claim on your tax return. For this reason, it’s important to maintain thorough financial and tax records to demonstrate your business operates with a profit motive.

Hobby income deduction rules

Can you deduct any expenses with hobbies? Unfortunately, the answer is “no.” Prior to the passing of the Tax Cuts and Jobs Act (TCJA), you could deduct hobby expenses as itemized deductions, but only up to the amount of hobby income you made. In 2018, the TCJA was passed, eliminating hobby deductions.

Hobby and business tax forms

If your hobby has become a business, you should report income and expenses accordingly. For instance, many small business owners will file a Schedule C: Profit or Loss from Business affixed to the 1040 tax form. This form allows you to report your business revenue, deduct eligible expenses, and calculate the net profit or loss from your business activities.

If your hobby remains a hobby, you should report the income received on Schedule 1, Form 1040.

Tax guidance resources

So, if you’re ready to take the leap, turn your beloved hobby into a flourishing business, and share your passion with the world, go for it! Just remember to consider the payroll, bookkeeping, and tax obligations. Block Advisors can help you determine whether you have a hobby or a business and the best ways to hold onto more of your money before and after tax season.

About the Author: Latasha Randle is a Strategy & Small Business Program Manager at H&R Block. In this role, she develops, implements, and executes small business strategy and initiatives that promote small business growth across tax, bookkeeping, and payroll. In addition, she develops training programs to support field associates in driving growth through effective execution.