A CPA PROVIDES TIPS FOR NAVIGATING THE HOBBY VS. BUSINESS DISTINCTION FOR TAX PURPOSES

Edited by Artisan Joy Staff

If you’ve started a creative business, you may be tracking expenses and saving receipts for possible business deductions come tax time. But did you know? The IRS has strict rules for classifying an activity as a business or hobby. If classified as a hobby, the business owner cannot claim expenses or losses from it on their tax return.

Certain forms of income, such as selling handmade crafts, may be more likely to be considered hobbies by the IRS as the federal agency scrutinizes those activities. We interviewed Tatiana Tsoir, CPA, MBA, over email to provide you with advice.

Artisan Joy: Creative entrepreneurs may not know that the IRS could classify their business as a hobby. What’s your advice?

Tatiana Tsoir: Be sure that you have a profit motive. For a non-hobby treatment, you have to show profit (net positive income) three out of [the] last five years (special exception for horse breeding of two out of [the] last seven years). If you do not show a profit in five years, your activity will be reclassified as hobby and all losses disallowed retroactively.

I would also advise to actually treat it as a business. This means keeping your business income and expenses in a separate account—even if it’s an account under your personal name. There is nothing that the IRS loves better than commingled funds to use that to disallow your deductions.

It’s natural for a new business, especially a creative business, to lose money early on or to break even. But, though it’s nice to use tax losses, it’s not a good thing to lose money, and it’s certainly not a good feeling.

AJ: What are some tips for helping a creative individual distinguish the sale of their art/goods as a business?

TT: To establish yourself as a business, you don’t have to necessarily register an LLC (though I would advise it) and can just open a bank account separately and be done. An LLC is a good idea to start with so that you don’t incur additional expenses for tax filing in the beginning. Once you reach $50,000 to $75,000 in net profit for the year, find someone to help you potentially convert to an S Corp. One caveat: lawyers love LLCs because of the limited liability protection—so I cannot blame them. But corporations provide the same level of protection. If you keep your LLC past $50,000-$75,000 in income as is, you will overpay taxes every year. And that’s a problem! Unless, of course, you like to overpay tax.

The bigger a business grows, the more you need a tax planner (proactive tax reduction) to restructure and possibly create a multi-entity structure, but I do agree with lawyers to get an LLC going—it’s the simplest, quickest and easiest thing and doesn’t require a separate filing (and payment). But keep the threshold in mind.

About Tatiana

Tatiana Tsoir, CPA, MBA , is an awardwinning Accountant, bestselling Author, Speaker and Entrepreneurship Expert. A fervent believer that the key to happiness lies in entrepreneurship, Tatiana encourages and empowers entrepreneurship and side-hustles at every age.

Over the last 17+ years, Tatiana has used her expertise in tax planning and price psychology to help hundreds of businesses become more profitable, stabilize cash flow, and pay less in taxes through a combination of tax strategies, operational planning, and commitment to excellence.

Tatiana now focuses on supporting individuals in building a business that changes lives, including their own. Tatiana is a frequent speaker at conferences, is the author of “Dream Bold, Start Smart: Be Your Own Boss & Make Money Doing What You Love” and host of the podcast Talk to Tatiana in which she has conversations with world experts about their entrepreneurial journey. Tatiana has been featured in Fortune, Forbes, US News & Report, Business Insider, GoBankingRates, Bankrate, CBS, The List, The Daily CPA, NTD, Thrive Insider, and National Speaker Association. tatianatsoir.com