Hobby Income Vs Business Income: What’s the Tax Difference?

So you have decided to start a business? Congratulations!! But what about you want to keep it as a hobby, or is it just all about your hobby which also helps you to earn money? So how do you differentiate between a hobby and a business when both are helping you to make money? You probably might ask whether it even matters; well, to be honest, it does because the income tax department cares about whether you have a business or hobby, so you need to learn the difference first to understand whether it comes under business or hobby and then you must know why it matters.

Factors To Be Considered

There are a variety of factors that helps you to understand that you are having a business than a hobby which are described below

• You want to make a profit through the activity that you are doing, even if you are unlikely to do it in the short term.
• You have decided to start a business and doing specific exercises that help the process, such as :
  1. registered the name of the business
  2. To obtain an ABN.
• You continue to repeat similar types of activities.
• The size of your business and the scale are identical to the other companies in your industry.
• All your actions are planned, organized and carried out like a business which may include
  1. keeping an account book and maintaining a business record
  2. having a separate business bank account
  3. operating from a separate premises
  4. having a license or qualifications
  5. having a separately registered business name.

How To Know If Your Hobby Comes Under The Business Category?

Ask the following questions to know if your hobby is a business, and if the answer for most of the questions is a yes, then your hobby is turning into a business.

• Do you maintain the necessary books and records of your business?
• Do you carry out the regular activity in a businesslike manner?
• Do you spend more time and effort to make it more profitable?
• Does your livelihood depend on the income generated from the activity?
• Do losses in your activity hamper or impact your livelihood?
• Do you often change the methods of operation to gain more profit? 
• Do you know how to carry out the activity as a successful business?
• Did you gain success in making a profit in similar types of activities in the past?
• Will your activity bring profit in the coming years? And are you keeping the profit record and how much profit it made in the recent past?
• Are you expecting to make a profit in future from the appreciation of the assets you use?

What Are Business Taxes?

The revenue earned from a business is constantly subjected to income tax and a 15.3 per cent self-employment tax to cover up the social security and medicare in case you are self-employed. To offset the taxable income, you can take up various business tax deduction methods for several qualified business expenses like phone service, internet service, travel expenses and even the startup cost, and possibly take a loss in case you are not experiencing profit from the business. You need to report business income and losses by using schedule C.

What Are Hobby Taxes?

If you receive any hobby income monthly, you must also have to report the hobby income to the income tax return. Hobby revenue is also subject to income tax, but you don't need to pay self-employment tax. Instead, you have to report hobby income on Form 1040 under a special section called "Other Income."

If you earn a hobby income from a side hustle, the income tax department will no longer allow you to reduce hobby-related expenses to offset your other income. It is a very recent change — before the 2018 Tax Cuts and Jobs Act, hobbyists were allowed to deduct the costs up to the amount of hobby income they generally earned. But you cannot deduct hobby expenses in the recent tax year 2022.

But the hobby loss rules are applied for all small businesses classified and sole proprietorships, along with partnerships and S corps. However, these rules do not apply to corporations with their business entity.

The Conclusion

Hope this above discussion has cleared all your doubts regarding business tax and hobby tax. Just ask yourself these questions mentioned above to understand where your activity belongs. Does it come under the hobby section, or is it an independent business? Therefore it will be easier for you to file the tax returns without hassle. In case of further queries or doubts, you can always get an opinion from a tax expert to understand the fundamental differences between hobby and business.