Caterer? Cupcake baker? Craft jeweler? Maybe even a glassblower? Your passion may have led to income. You should know about the special rules and limits for deductions.
To start with, is your passion a business or a hobby? The IRS says people start a business to make a profit, whereas a hobby can be engaged in as a sport or for recreation. Here are some factors to help you decide:
The answers you give should be based on facts and circumstances, the agency states. If you have determined that you have an expensive hobby, can you deduct any of your expenses? With the passage of the Tax Cuts and Jobs Act, the short answer is no.
If you're legitimately in a business, you can deduct expenses for that business and possibly take a loss if your business isn't profitable. If you're not in business to make a profit, the IRS considers that your activity is not for profit and says you cannot deduct expenses to get a loss to offset other income.
Many legitimate businesses start out with a loss in their first few years. However, the IRS expects that a legitimate business is set up with the intention to make a profit. Let's take the example of an artist who wants to claim expenses. The artist has to show that he or she is following good business practices and intends to make a profit.
A legitimate business, according to the IRS:
In general, although there may be exceptions, the IRS will let you call what you have a business if you earn a profit during any three out of five consecutive years.
Being able to show that you employ good business practices should help, too. These include:
Are you unsure about what you have on your hands? Or do you want to explore turning a hobby into a business? Get qualified legal and financial advice to make sure you're following the rules — and not missing out on any tax breaks you're entitled to.
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