When we think of hobbies, many of us think of pastimes such as reading, painting, or golfing. While many people enjoy hobbies as a way to spend their free time, some hobbies are also a source of income. Taxpayers who generate money from a hobby must report that income on their tax return. However, expenses related to income earned from a hobby are miscellaneous itemized deductions and are no longer deductible after the Tax Cuts and Jobs Act. This differs from the treatment of expenses related to carrying on a trade or business, which are generally deductible. Thus, it is very important to differentiate whether your income is being generated via hobby activity or from a trade or business.
A business, though it may be enjoyable, is operated to make a profit, while a hobby is engaged in for pleasure or recreation, regardless of any profit motive.
While the determination of whether an activity is a business or a hobby can be heavily fact-dependent, the main determining factor is whether or not the activity is carried on to make a profit. A business, though it may be enjoyable, is operated to make a profit, while a hobby is engaged in for pleasure or recreation, regardless of any profit motive. The IRS has outlined nine factors that taxpayers should consider to help determine if their activity is a business or a hobby:
Since the determination of whether an activity is a hobby is highly fact-specific, the IRS has provided a safe harbor in determining if the activity is engaged in for a profit. To meet the safe harbor, an activity must make a profit in at least three of five consecutive tax years ending with the tax year in question. For activities involving horse racing, breeding, or showing, a profit must be shown in at least two of seven consecutive tax years ending with the tax year in question. If the taxpayer has met the safe harbor, then the burden of proof in proving lack of profit motive is shifted to the IRS. If the safe harbor is not met, then the burden to prove a profit motive is on the taxpayer. Taxpayers should keep specific and well-documented support of the profit motive for each activity.
Determining whether your activity is a business or hobby may be very complex and can have significant tax consequences. If you have questions about how an activity and its income or losses should be classified, please contact your P&N tax advisor to help you make this determination.
 I.R.C. § 183(d).