Careers such as baking cakes, starting a blog or offering tour guiding services give people a way to make money from their passions. But the IRS wants to know about that income.
You generally have to report all income to the IRS, whether it comes from work, Social Security, unemployment benefits or something else. Income from a hobby is no different, although it is treated differently than income from a business. Here’s what you need to know, and how to avoid the side tax trap.
The IRS expects you to report taxable income
Side income is usually taxed, regardless of whether it comes from part-time work, part-time gigs or online marketplaces. The IRS says you must report gig economy income even if it’s not reported on a tax form like Form 1099 or W-2. Reporting is required as soon as your self-employment income exceeds $400 per year (and may be required otherwise) and you may owe self-employment taxes.
You could end up with a huge (and surprising) tax liability, called the side hustle tax trap. A few rides you’ve driven for Uber or pet-sitting jobs you’ve taken with Rover will be on the IRS’s radar as taxable events. Setting aside some money can make it easier to pay taxes on time, which is why you usually need to pay estimated taxes quarterly throughout the year. If you are not sure how much you have to pay, you can talk to a tax professional.
Hobby vs. business: The difference comes down to relative profit
The IRS sees income from a hobby differently from income from a business: “The main difference between the two is that businesses operate for profit while hobbies are for entertainment or recreation,” according to the agency.
The IRS adds that you should ask yourself whether your intent was to make a profit, whether you can expect future profits from the job, how much you earned, whether you depend on income, whether the jobs were modified to improve profits and more.
Income from a hobby is generally not subject to self-employment tax. But you also can’t deduct expenses related to your hobby.
Practical steps to help avoid problems
If you see yourself making money from a hobby for a long time, it often makes sense to separate personal and hobby money. You can start with a separate checking account, but if the business is just getting started, you may want to think about building a business and getting a business bank account.
You should also track your income and expenses carefully, so that you don’t underreport your income, but also so that you can deduct business expenses. You will also need to do your own version of the tax deduction as the employer will not do it for you.
Consulting a tax professional can help you avoid some of the common mistakes people make when turning their hobbies into profitable side hustles. They can walk you through all the necessary forms and help you confirm which expenses are deductible.
