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