That seems like an easy question for photographers, do you have a hobby or a business? But hobby vs. business is not always that easy to figure out, and the answer can change over time.
Determining whether you have a hobby or a business is important for income tax reasons. If you have a hobby, you can only deduct expenses related to that hobby up to the amount of income that you make from your hobby in that tax year. Expenses that are more than the income you have made are considered personal losses and can not be deducted like business expenses.
Business expenses or business losses can offset other income on your tax return, such as income from a full-time salaried position because perhaps photography is your part-time business. However, in order to be considered a business, the IRS presumption is that you are participating in that business activity to make a profit.
That is the key language, “you are in business to make a profit.” Hobbies cost money. Businesses make money. And you can bet that the IRS pays close attention to whether you have a hobby or a business. Why? Because they want their money and if you are getting tax breaks on your hobby, they aren’t going to like that!
The IRS has set out several factors taxpayers should be considering when determining whether they have a hobby vs. a business:
Does the time and effort put into the activity indicate an intention to make a profit?
Does the taxpayer depend on income from the activity?
If there are losses, are they due to circumstances beyond the taxpayer’s control or did they occur in the start-up phase of the business?
Has the taxpayer changed methods of operation to improve profitability?
Does the taxpayer or his/her advisors have the knowledge needed to carry on the activity as a successful business?
Has the taxpayer made a profit in similar activities in the past?
Does the activity make a profit in some years?
Can the taxpayer expect to make a profit in the future from the appreciation of assets used in the activity?
You have probably heard about the infamous three out of five year rule — the IRS presumes an activity is being carried on for profit if it makes a profit during at least three of the last five tax years, including the current year.
For more information on determining whether you have a hobby vs. business, check out these resources:
Note that hobby expenses are deducted as itemized deductions on your income tax return, on Schedule A as a part of miscellaneous itemized deductions. If you have any questions regarding whether you have a hobby vs. a business, talk to your accountant. It can be costly if you find out later that you have taken a deduction for business expenses that you should have because you actually have/had a hobby.