When Has Your Hobby Become a Small Business?

by Sean Bryant on September 27, 2013

Small BusinessYou’ve been writing poetry for years and decide it’s time to share your passion with the world. With a small investment, you are able to create an attractive and unusual book and publish it on the Internet. To your surprise, the book starts selling, and you are regularly making a modest amount of royalties every week. You create a blog, begin writing regularly, and as you begin to invest more time in your poetry and promotion, a question emerges: at what point does your hobby turn into a small business, and what difference does it make? This question can be asked for any number of pleasurable hobbies you might enjoy on a regular basis and from which you may make a small (or large) amount of income. Forbes estimates that there are 11 million entrepreneurs in the United States, with 320 new businesses launched every month per every 100,000 adults. Has your hobby put you in the category of U.S. entrepreneurs?

Does it matter whether my hobby is actually a business?

To answer that question simply, yes, it does matter. For tax purposes, the IRS considers any hobby a business if it has made a profit in three of the past five years. Expenses may be deducted from income earned on the hobby-turned-small-business. With initial startup costs usually involved with starting a new business, initial losses can be claimed. This offers a distinct advantage for taxpayers. If losses are sustained for more than three of the past five years, however, then the business is no longer considered by the IRS to be a business, but a hobby, Entrepreneur reports.

Criteria for determining when a hobby is a business

Consider some points for determining whether your hobby has become a business.

  1. The manner in which the business is conducted – Is the hobby-turned-small-business conducted in businesslike manner, with complete and accurate books and records? Does the businessperson abandon unprofitable practices in pursuit for greater productivity and higher profits?
  2. Time and effort spent in pursuit of the hobby and producing income – Accounting.com notes that spending a significant amount of “personal time and effort” in an endeavor to further the hobby and the business elements of a hobby is good indication the hobby has become a small business. This is especially the case if a substantial part of that time does not include personal or recreational aspects. When motive is interpreted as being profit, this indicates that the hobby may now be a business.
  3. Does the hobbyist/entrepreneur depend on income from the activity in question? If proceeds derived from the hobby is regularly being used by the hobbyist as income, then this is also a good indication the hobby is a small business.

What is Profit?

Investor Words defines profit as the “positive gain from an investment or business operation after subtracting for all expenses.” The Consortium for Entrepreneurship Education elaborates further, stating that profit is the difference between the amount of money the business makes after expenses such as cost of goods sold, insurance, overhead, and taxes. The IRS states that interest “that was used for paying in business purchases is deductible” from income and that all “ordinary and necessary” business expenses are deductible against income earned when determining profit.

Organize your hobby towards becoming a business

As your hobby morphs towards becoming a small business, organize it for more income potential and greater profits. Small business startups should include these steps: register your business with local, state and federal agencies; keep separate books and records for your business; prepare invoices; and have a separate location in your home, preferably a room, used solely for your business. Use a business credit card through which you earn rewards points that you can then use for employee gifts, airfare, electronics, and similar purchases. Reports generated from a suitable business credit card will help you keep organized, keep track of expenses, and will be of advantage during the tax season.

Have any of you turned a hobby into a career?

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Sean Bryant

Sean Bryant created OneSmartDollar.com in 2011 to help pass along his knowledge of finance and economics to others. After graduating from the University of Iowa with a degree in economics he worked as a construction superintendent before jumping into the world of finance. Sean has worked on the trade desk for a commodities brokerage firm, he was a project manager for an investment research company and was a CDO analyst at a big bank. That being said he brings a good understanding of the finance field to the One Smart Dollar community. When not working Sean and he wife are avid world travelers. He enjoys spending time with his daughter Colette and dog Charlie.

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  • Great post! I have started a couple of business that could have been considered hobbies; however, I always had the intention of generating income. Both times I got a fictitious business name and opened a sole proprietor bank account to keep my personal banking separate from the business.

    I’m not sure that I wouldn’t have been better off just starting as a hobby and not using the deductions. It puts a lot of extra stress on you to generate income so that you don’t cause any tax problems for yourself.

    I’m working hard this time to generate income. I think this line in your post hit me the hardest: “Does the businessperson abandon unprofitable practices in pursuit for greater productivity and higher profits?”

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