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Bob Cassel

Turn Your Hobby into a Business and Save Taxes

by Bob Cassel, EA, CFP® / Fall 2003 / Tax Planning

Why would you want to turn something you enjoy and do for fun into something that is intended to generate income? To save money on taxes, of course. In this article, we are going to explore the pros and cons of turning your hobby into a business. We will assume that you have a hobby that could legitimately earn some money. Good examples are photography, quilt making and other crafts, genealogy, and writing. Other possibilities would be activities that people might pay you to teach them or guide them in (kayaking, playing an instrument, etc.).

Making this transition offers some definite advantages. First of all, you may earn some extra income. Secondly, you may actually reduce your income tax liability. It is true that you will have to declare any income you receive from pursuing your hobby as a business. However, you will also be allowed to deduct dollar for dollar any expenses you incur producing that income, often generating a loss for the business and lowering your overall tax bill. Deductible expenses include:

  • Full deduction for direct expenses in producing the income – Materials, supplies, advertising, office expenses, training, education, bookkeeping supplies, and the cost of any labor by employees or independent contractors.

  • A percentage deduction for expenses used partially for the business – Home computers, software, connectivity, office furniture, an area in your home set aside as an office, cellular and land-line phone.

  • Automobile expense deduction for travel between places of business – If you have another job besides your business, you can deduct auto expenses for travel between your home office and regular job.

  • Partial or full deduction for travel that focuses partially or entirely on your hobby – The business portion of these expenses for you and your employee (say, your spouse) would be deductible. Trips to a conference, trade show, or to do research are a few possibilities. The deductible expenses would include hotel, meals, local transportation, and any other expenses while you are away overnight on business.

  • Medical insurance deduction – If you buy medical insurance for yourself and your employees (including your spouse and children if you employ them), you could receive a large deduction for this expense. (To qualify for this deduction, you cannot receive health insurance through another employer.)

  • Retirement contribution deduction – You could make deductible contributions to IRAs for your employees (including your spouse and children if you employ them).

The downside of converting a hobby to a business is that you must commit to “trying” to earn a profit. In addition, once you have made the conversion, you cannot easily reverse it. The IRS guidelines say that in order to be considered a business, you must show a profit in 2 out of every 5 consecutive years. But, there are exceptions to this rule. For example, you can still qualify as a business if you can show adequate intent to make your business profitable. Ways to prove this profit motive include advertising, sending out bids or proposals, and joining professional associations or trade groups.

However, if you transition your hobby to a business, show a loss for 1 or 2 years, and then decide to go back to hobby status, the 1 or 2 years of deductions will probably not hold up under IRS scrutiny. You must be prepared to continue the business for several years.

If the idea of converting your hobby to a business appeals to you, first be sure you meet the following requirements:

  • A desire and the opportunity to turn your hobby into something that generates both income and business deductions

  • Acknowledgement that you will need to show a profit, or demonstrate intent to make a profit

  • A willingness to carry on this business activity for several years or more

Once you have decided to convert your hobby to a business, new questions are likely to arise: “Which deductions can I qualify for?” “What record keeping is required?” “Should I employ my spouse or children?” “What type of business entity should I choose?” Do not worry. Just give us a call and we will help you through the decision making process.



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