Is Your Passion a Side Hustle aka Business or Just A Hobby?

While the term “side hustle” has become the new description for “gig” or “moonlighting” for professionals who try to earn an income on the side, the term itself does not mean it’s a business.  Why does it matter if it’s a business or not? Why does it matter if your cupcake blog, youtube vlog, or instagram influencer campaign is making any real money? The answer is that it doesn’t, until you have to file federal income taxes with the Internal Revenue Service (IRS). Come tax season, you should know if your side hustle is a legitimate business or just a hobby you are passionate about.

Why You’d Want to Have a Business

If you’re still not clear as to why you’d want your side hustle to be considered a legitimate business for tax purposes, then it’s time to brush up on deductions.

When you have a business, even if it’s a gig you do on the side to supplement your income, you tend to have expenses. Those expenses could be your space, your time, your equipment, the dollars you spend at a coffee shop to get work done outside the home, or advertising.  If you’re hustling on the side without it being a “business”, those costs eat into your profit margin.  You still have to report your income, but you can’t deduct any investments, expenses, or losses.

If you have a business, then suddenly you can deduct your startup expenses, your losses, and you can even rollover your losses to a previous or future tax year to reduce your overall tax burden.  In short, you can pay less taxes.

Is My Hobby a Business?

Generally, the IRS determines your side hustle or freelance gig is a business if it meets these five requirements:

1. You dedicate sufficient time and effort into the “business”.
2. You have the ability/skill/certification necessary to run the business and make a profit.
3. You perform the side hustle for the purpose of earning a profit.
4. Your side hustle generates a profit in three out of the last five years.
5. If you do not make a profit, you make changes to improve your profitability.

What this means is that if you have a side business that doesn’t make a profit in the sense that you spend more on materials, equipment, and space, causing you to actually lose money or not earn much from your business, then it is a hobby.

A good example is someone we know who has a full-time job, but on the side makes soap to sell online.  She has a designated space in her home where she has her office and “laboratory” for making soap, so she deducts rent/loss for her space as a business expense.  She would also deduct her expenses, such as soap materials, equipment she needs, and all costs related to her online sales.  After deducting all her expenses, it turns out she’s really not making much out of her essential-oil all-natural soap business.  However, she enjoys making soap. It’s a calming activity that is like meditation for her.  If our friend does not improve her strategy, reduce her expenses, and sell more soap so that she can earn a profit, she stands to lose her deductions and owe full taxes on her hobby income.

Don’t Let Your Startup Become a Hobby

When founding a startup, it’s important to keep in mind that if it’s too hobby-like, and doesn’t generate a profit in two years, then you may lose your business deductions and owe federal income taxes.

Have questions? Talk to a tax law specialist today!