Be prepared! The middle-age man fiddling around the garage, the young mother sweating at the sewing table, or the sisters cake decorating are starting to sell, you may not be a hobbyist anymore. The IRS is watching and ready to tell you when you have crossed the line.
Most entrepreneurs or solopreneurs have passion and interest in what they do. That is the intense feeling people get when they are fully immersed in something. It is that adrenalin rush people feel when someone sneaks up behind them while they are working.
And, so they may go on, selling an item now and then and rolling most of the revenue back into new supplies. Then, before they know it, someone ordered three or thirty, three dozen or three hundred. And, in a rush to fill the order, they fail to notice this is not just a hobby anymore.
That’s the Internal Revenue Service threshold: once the product or service is sold for profit, it is no longer a hobby.
- Newsworthy: When the hobbyist gets a reputation for doing things well, for selling to customers in a market, for getting noticed, it is one sign that a business is going on.
- Overworked: When word-of-mouth or social networks bring in more orders than are manageable and help is needed, this just might be a business,
- Profit: A hobby sinks everything and every penny into the work and outcome. But, it is a business when there is a profit and a plan to make more.
- Debt: When the hobby starts costing and building debt – with the expectation of debt retirement – this is a business.
- Plan: If there is a business plan for additional growth, the craft is not a hobby anymore.
It is time to talk to an attorney and shape things up because the IRS will consider this an active business subject to different rules and rates than an individual. It can hurt both ways:
- If a hobby, there are no deductions for material, personnel, and business expenses.
- If a business, there are no regulations to comply with – some of them costly.
How to make friends with the IRS:
- If there is a profit on the sale of heretofore hobby items – handmade, promotional, print, clothing, animal, vegetable, or mineral – report it as income. (If there is a profit in 3 consecutive years, it is time to get serious.)
- Avoid using the word “hobby” in advertising, communications, and websites.
- Create a business plan with reasonable expectations for three to five years out.
- Start a separate bank account for business income and expenses.
- Keep financial records; at the beginning, they do not have to be much more than the bank statements for that separate account.
The possibility of meeting new IRS requirements is no reason not to expand a hobby with a profit interest. Nonetheless, to do so enters a different arena, one that requires much more commitment and time. It should not be entered lightly or inadvertently.