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Navigating Side Hustle Tax Responsibilities

Writer's picture: CARRIE LOWECARRIE LOWE

In today's dynamic economy, side hustles have become a common way for many people to boost their income. Whether you're selling handmade crafts on Etsy, freelancing as a graphic designer, or driving for a ride-share service, the additional income can be significant. However, with this extra income comes additional tax responsibilities. One of the most crucial distinctions the IRS makes is whether your side hustle is a hobby or a business. Understanding this classification is essential for managing your taxes effectively and avoiding potential issues with the IRS.





A Hobby or A Business


The IRS uses several factors to determine whether an activity is a hobby or a business. The key difference lies in your intent to make a profit. Here are some of the main considerations:


  1. Profit Motive: The primary factor is whether you engage in the activity with the intention of making a profit. If you consistently make a profit from your side hustle, the IRS is more likely to consider it a business.

  2. Time and Effort: The amount of time and effort you put into the activity can also indicate whether it is a business or a hobby. Significant time and effort suggest a business, especially if you depend on the income for your livelihood.

  3. Dependence on Income: If you rely on the income from your side hustle to pay for your living expenses, it's more likely to be considered a business.

  4. Expertise: Your level of expertise in the field can be a factor. If you have extensive knowledge or have sought professional advice, it indicates a more serious business endeavor.

  5. History of Income and Losses: A history of making a profit in similar activities can influence the classification. Conversely, if the activity has a long history of losses, it might be seen as a hobby.

  6. Elements of Personal Pleasure: Activities done mainly for recreation or personal enjoyment are more likely to be considered hobbies.


Tax Implications


Hobby


If your side hustle is classified as a hobby, the income must still be reported on your tax return. However, the tax treatment of expenses is different. As of the Tax Cuts and Jobs Act (TCJA) of 2017, hobby expenses are no longer deductible. This means you must report all income earned from the hobby but cannot deduct any related expenses.


Business


If your side hustle is considered a business, you're required to report all income and can deduct related expenses. Business expenses are reported on Schedule C (Form 1040), Profit or Loss from Business. Deductible expenses can include supplies, advertising, home office expenses, and more, as long as they are ordinary and necessary for your business.


Reporting Income from Payment Apps


Whether your side hustle is a hobby or a business, if you receive payments for goods or services through payment apps like PayPal, Venmo, or others, you may receive an IRS Form 1099-K. This form reports the total income received through these transactions and must be included on your federal tax return. The payments are considered taxable income, regardless of the nature of your side hustle.


Keeping Accurate Records


Regardless of whether your side hustle is a hobby or a business, keeping accurate records is essential. Maintain detailed records of all income and expenses related to your side hustle. This includes receipts, invoices, bank statements, and any other documentation that supports your financial activities.


Making the Transition


If you initially start your side hustle as a hobby but it grows into a profitable venture, you may need to reclassify it as a business. This change will allow you to deduct business expenses and potentially reduce your taxable income. It’s advisable to consult with a tax professional to ensure you make the transition smoothly and comply with IRS regulations.


Seeking Professional Advice


Navigating the complexities of tax responsibilities for a side hustle can be challenging. If you're unsure whether your activity is a hobby or a business, or if you need assistance with tax planning and preparation, consider consulting a tax professional. They can provide valuable guidance tailored to your specific situation and help you stay compliant with IRS regulations.


Conclusion


Side hustles can be a fantastic way to earn extra income and pursue your passions. However, it's crucial to understand the tax implications and ensure you classify your activity correctly as either a hobby or a business. By keeping accurate records and seeking professional advice when needed, you can navigate the tax responsibilities of your side hustle with confidence and avoid potential pitfalls.


Remember, the IRS is primarily concerned with whether you are trying to make a profit. Demonstrating a profit motive and maintaining good records are key steps in ensuring your side hustle is treated appropriately for tax purposes.

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