The Definition of "Hobbies" for Taxes
The Internal Revenue Service treats income that you earn outside of a job as business income or hobby income, depending on the financial circumstances surrounding the income. You can take greater tax deductions on business income than on hobby income, but you must pay higher taxes on it as well.
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Intention
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If the person's main purpose in engaging in the activity is to make a profit, the IRS considers the activity a business. For example, if a person makes clay models primarily to sell them to others, that activity would be considered a business rather than a hobby. If an activity made a profit in three out of the last five years, the activity is considered a for-profit activity and therefore is not a hobby.
Dependence on Income
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If the person is dependent on income from the activity, it is a business rather than a hobby. For example, a person who has a regular job and sells homemade jewelry one or twice a year has a jewelry-making hobby. A person who does not have an outside job and sells homemade jewelry every weekend at the local flea market to pay his bills has a jewelry-making business.
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Losses
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While an activity that makes a profit in three out of the last five years is definitely a business, an activity that causes the taxpayer to lose money may not be a hobby. If the taxpayer lost money because of expenses associated with starting the activity, those expenses may be considered startup expenses for a business. If the taxpayer lost money for reasons beyond his control after starting the activity, such as the cancellation of events associated with the activity, the activity may be considered a hobby.
Tax Deductions
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Hobbyists may not deduct losses associated with the hobby from their income, while business owners can. However, hobbyists can deduct expenses up to the amount of income that they earn from the hobby. For example, if a knitter spend $1,000 on supplies but only earns $300 from her hobby, she can only deduct $300 from her taxes, while a person who has a business associated with knitting can deduct the full amount of expenses.
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