Hey, digital nomad. Is that a business or a hobby? Or is that hobby now actually a business? If your hobby or side-hustle is bringing in the dough, good for you! But how do you report hobby income on taxes?
First, I commend you for making money at your side hustle. That’s amazing!
It means you have extra money to save for retirement (it can be early retirement) or colleage or that dream van you’ve had your eyes on for a while, or spend more on the fun things as you travel, or even possibly quit your day job. Since hobbies are enjoyable, it’s a win-win situation.
But like most other income, income from your hobby (side-hustle) is taxable. Don’t think that since it’s not your full-time gig, it doesn’t count as income. Taxes are a considerable expense, so they should be minimized, when possible.
This is a touchy issue for the IRS. Many people try to deduct losses for activities that are primarily conducted for enjoyment. It’s easy to get yourself into trouble.
How to Report Hobby Income on Taxes
For tax purposes, understand what “hobby” means.
The IRS considers a hobby to be an activity that is done primarily for enjoyment, not for making a profit. If your activity is considered to be a hobby, you can’t use the tax deductions available to legitimate business. However, you will be taxed for profit and can deduct your expenses in the same year.
For example, if you bought $1,000 in rare coins and didn’t earn any income, you can’t deduct the $1,000 on your tax return. However, if you sold the coins for $1,200, you would be taxed on the $200 profit.
Another example, you like to paint and spend $4,576 on painting supplies during the year. However, some friends notice your painting and buy them for a total of $5,000. You now have some income to report on your tax return AND you can deduct the cost of your art supplies.
Hobbies are terrible for tax purposes.
It’s important to create a business for your hobby. Think business, not hobby. If you expect to make a profit, and your expectation is considered to be reasonable, then you can consider your hobby to be a business.
HINT: If your hobby is making money, it’s a business.
There is no advantage to not declaring your hobby a business if your intention is to earn income. When it comes to the IRS, remove the word hobby from your vocabulary.
Call it a side hustle or small business but don’t use the word “hobby.”
Consider hiring your non-working family members.
Remember that no income tax has to be paid below a certain income threshold. Paying your children or non-working spouse a salary to help you with your business is a great way to avoid income taxes.
Paying your spouse keeps the money in your collective pockets.
Paying your children provides a great way to save money for college or contribute to a Roth IRA, tax-free. Ideally, you can be in the position to do both if you have a spouse and kids.
Invest the profits in tax-deferred retirement accounts.
Is your goal early retirement? Is that the whole point of the side hustle? Don’t have kids to pay. No worries. I got you covered.
Contribute to a tax-deferred retirement account or invest the money another way.
Depending on how much income you earn, your options will vary. But at the very least, a SEP IRA makes a lot of sense. You can shield your income from taxes, at least temporarily.
A Roth-IRA requires after-tax income, but the earnings are tax-free. A traditional IRA uses pre-tax income, but the earnings are taxed.
IRAs are great, but remember the money is out of your hands until the standard retirement age. If you want to retire early and need that money, be sure to invest the money wisely. Plus, you should avoid spending the extra income on other things.
This article isn’t all about advice on early retirement but you definitely consider your options for tax savings if you can.
Maximize your income for the amount of time you want to dedicate to your hobby. Don’t hesitate to get expert tax advice, too.
A moneymaking hobby can be an important part of any early retirement plan. Think about the things you like to do and make a list of ways you can make money from those activities. But take the steps to avoid paying more taxes than necessary.
Learn how to run a business wisely. Need help learning about how run a business effectively?
Have you seen Nomad Business Academy? It’s all about learning how to run a business, understand business finances, get a clear understanding of tax obligations, and so much more.