Being a writer is a wonderful hobby for many people. But, it is a business for many others. There is a significant difference when it comes to income taxes.
Hobbies can be a source of income, either accidently or intentionally. You must report any income you get from a hobby on your tax return. How you report the income from your hobby is different than how you report your income from a business. There are special rules and limits for deductions you can claim for a hobby. Here are six basic tax tips you should know if you get income from your hobby:
- Business versus Hobby: The first thing you must do is determine if you are operating a business or participating in a hobby. There are several ways of approaching this question. Do you conduct your affairs in a business-like manner? Is it your intention to make a profit or enjoy your hobby? The IRS will want to see you as participating in a hobby while you will want to see yourself as operating a business.
- Profit Test: The IRS looks at the hobby or business question by looking at profit. If you have a loss in any 3 of the last 5 years, the IRS will consider you as having a hobby. But, if you show a profit in any 3 of the last 5 years, the IRS would consider that you are operating a business. You can file Form 5213 which will postpone when the IRS makes it’s decision about whether it is a hobby or business until the end of year 5. For writers, there is a timing problem with income and expenses. Writers’ tend to have no income in the early years when they are primarily writing.
- Hobby Expenses: You may be able to deduct hobby expenses. In general, you can only deduct your hobby expenses up to the amount of your hobby income. If your expenses are more than your income, you have a loss from the hobby. You can’t deduct that loss on your tax return.
- How to Report Income & Expenses: You must report your hobby income on line 21 of your tax return which is Other Income. This increases your income by the full amount of the hobby income. However, for your expenses, you report them as Itemized Deductions on Schedule A of your tax return. Unfortunately, these expenses are not fully deductible depending on your circumstances. The primary limit is that the amount of hobby expenses cannot exceed your hobby income. After that there is a 2% of Adjusted Gross Income (AGI) deduction.
- Business Use of Home: You may be able to take a deduction for the business use of your home. For example, let’s say that there is a room where you do your writing. Then you may deduct the expenses for that room on your tax return (see Form 8829). But there is a problem, the space must be used exclusively for your writing and not for any personal use whatsoever.
- Business Income: Business income is reported on Schedule C of your tax return. You report your income and all the related expenses necessary to earn that income. If there is a loss it will be offset against your other income and save you tax dollars. If there is a profit it will increase your taxable income. It will also trigger Self-Employment taxes (Social Security and Medicare).