Tax Deductions for Hobbies vs. Businesses: Will this purchase offset my income?
A client who works full-time came to us with a great question - “If I start a band and purchase $5000 of equipment, can I write it off as a tax deduction?”
This is a really common question, and you might find yourself wondering, “can I write off the purchases I made for my side-hustle?” or “will these count as a tax deduction and offset the income I made?”
These are important questions, especially when you are getting started. There are a lot of misconceptions about tax deductions, and in this post we will answer a few key questions to help you make an educated decision. If you still have questions, don’t hesitate to reach out!
Is it a Hobby of a Business?
The first question to address when starting up an activity is to determine whether it is hobby or business. If it is a hobby, expenses may be deducted only to the extent there is income. If it is a business, expenses deducted may exceed income.
Here is what the rules say: If a business or investment activity is not conducted as a for-profit business, IRC section 183 limits deductions to the amount of income from the activity. This rule applies to individuals, partnerships, estates, trusts, and S corporations (but not to other corporations).
If an activity is considered a for-profit business, deductions can exceed income, allowing the resulting loss to offset other income.
2. The Differences Between a Hobby and a Business
You can ask yourself the following questions to help you determine if your side-gig would be considered a hobby or a business in the eyes of the IRS.
This is not an all-inclusive list, but it is a great place to start. If the answer is yes to these questions, you would most likely be considered a business, and tax deductions may exceed income and offset other income.
Does the taxpayer carry on the activity in a businesslike manner, including the maintenance of complete and accurate books and records?
Does the time and effort put into the activity indicate an intention to make a profit?
Does the taxpayer depend on income from the activity for his or her livelihood?
Are any losses due to circumstances beyond the taxpayer’s control?
Are losses normal in the start-up phase of this type of business?
Has the taxpayer adapted methods of operation in an attempt to improve profitability?
Does the taxpayer (or taxpayer’s advisors) have the knowledge or expertise needed to carry on the activity as a successful business?
Has the taxpayer made a profit at similar activities in the past?
Does the activity make a profit in some years?
Does the taxpayer expect to make a profit in the future from the appreciation of assets used in the activity?
How significant is the element of personal pleasure or recreation in the activity?
See Regulation section 1.183-2(b) for more discussion and examples.
3. Getting Help with Deductions
A good accountant can help you make purchase decisions based on your unique situation, and can help avoid expenses tax surprises.
The start-up period can be tumultuous, and starting with a firm foundation of accounting and tax advice can set you off on the right foot, with the confidence you need to grow your venture.
If you need help determining if your situation is a hobby or a business, and are looking for help with your accounting and taxes, our team can help. Learn more about our accounting services, our tax services, or reach out to our office to schedule a consultation.