hobby

Hobbies vs. Side Hustles

These days, “side hustle” has become quite the buzzword. But what is the difference between a hobby that’s bringing in extra income and a business? Whether you’re selling your paintings, pottery or woodworking, this income needs to be reported on your tax return, although not in the same way as business income.woodworking hobby

So what’s the difference? The IRS declares that individuals “operate a business to make a profit,” while, “people engage in a hobby for sport or recreation.” To help you determine whether your activity qualifies as a hobby, the IRS has composed the following list of factors:

  1. Like a business, do you maintain books and records for this activity?
  2. When you invest your time and efforts into this activity, are you intending to make a profit?
  3. Do you depend on the income from this activity for your livelihood?
  4. Are your losses from circumstances beyond your control? (*versus a startup phase of a business)
  5. Do you alter your operations to improve profitability?
  6. Do you have the knowledge to conduct the activity as a successful business?
  7. Have you successfully made profits on these activities in the past?
  8. Are there certain years your activity makes a profit?
  9. Could you expect to make a future profit from the appreciation of assets you use in this activity?

Fitting one of these factors alone does not automatically deem the activity a business. Rather, it’s best to consider all of these factors and circumstances in respect to your activity.hobby

If it’s a business…you are able to deduct losses. However, you will have to complete Schedule C, as well as pay income tax and self-employment taxes.

If it’s a hobby…you can no longer deduct expenses related to hobbies. Report your income on Schedule 1, Form 1040, line 21 (Other Income).

In conclusion, it’s always best to keep as detailed records as possible, in case of an IRS audit. Don’t let the threat of taxes on your hobby income deter you from conducting your hobby. Continue what you love, and if you don’t want to pay taxes on this activity, don’t sell your goods for income.

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records

Retaining Your Tax Documents

Whether the results of this most recent tax season had a positive or negative impact on your bank account, it’s important to consider how long you should retain your tax documents. This includes a copy of your tax return and any documents providing support of income or deduction items, as well as evidence for any credits received.  A period of limitations is determined by the IRS based on the time in which you could amend a return to claim a credit or refund, or during which the IRS can assess additional tax.

The general rule of thumb is three years. This means you should retain a copy of your return and supporting documents for that return until three years from the filing due date. For example, you should keep the information regarding the return that was due April 15, 2019 until April 15, 2022, at the very least. Keep in mind, these periods are federal guidelines. States may have their own statute of limitations.tax records

Exceptions

There are a lot of “buts” in tax circumstances. Fittingly, if you claim a bad debt deduction or a loss from worthless securities, retain your records for seven years instead of three. If you have ever filed a fraudulent return, or forgotten to file a tax return, the IRS requires you keep your financial records for your lifetime.  Finally, if for some reason, 25 percent of your income was not reported on your tax return, the IRS has up to six years to impose additional tax.

Period of limitations

The IRS has provided the following information on a period of limitations for different scenarios:

  1. Keep records for 3 years if situations (4), (5), and (6) below do not apply to you.
  2. Keep records for 3 years from the date you filed your original return or 2 years from the date you paid the tax, whichever is later, if you file a claim for credit or refund after you file your return.
  3. Keep records for 7 years if you file a claim for a loss from worthless securities or bad debt deduction.
  4. Keep records for 6 years if you do not report income that you should report, and it is more than 25% of the gross income shown on your return.
  5. Keep records indefinitely if you do not file a return.
  6. Keep records indefinitely if you file a fraudulent return.
  7. Keep employment tax records for at least 4 years after the date that the tax becomes due or is paid, whichever is later.shred

Disposal

A good scanner has made the electronic retention of these records fairly efficient. However, when disposing of your records and prior tax returns, it’s important to shred any physical documents that may bare identifiable information. Poorly disposed of documents could make you susceptible to identity theft. For electronic information, be sure to have strong security software in place. Keep in mind, that although the IRS may no longer have a use for your records, they could be needed by your insurance company or creditors, in some cases.

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