Here is the exact question you need to answer to make a decision
Do you sell your paintings to others via an Etsy shop, RedBubble, or gallery?
Congrats!
This can be a great way to express your creativity and make a little income.
But do you have a hobby or a business? Because understanding the difference is important legally (and come tax time).
One of the most common questions I get from those who have a hobby and then start to generate a little income is,
“Do I have to invest in getting permits, licenses, or other things if I'm not making a profit?”
And by the end of this post, you’ll know if your thing is a hobby or a business according to the law, and more importantly, the IRS.
The hobby or business test
On your personal taxes, you are required to
- report all income for your hobbies
- report all income for your business
But only businesses are allowed to deduct the expenses that were necessary to earn the income.
The official IRS hobby or business test is more complex than the test that I use, but they both boil down to the same exact thing:
Do you hope to make a profit?
The IRS test asks you to consider nine things:
- Is the activity carried out in a businesslike manner and are you keeping complete and accurate books and records?
- What time and effort are you putting into the activity?
- Do you depend on the income?
- Are the losses expected based on the stage you are at in your business?
- Are you changing how you are running your business to make it more profitable?
- Do you have the knowledge necessary to run a successful business?
- Have you made a profit doing similar things in the past?
- Have you made a profit in some years? How much?
- Can you expect to make a profit in the future based on your current assets?
Like most IRS tests, this isn’t a test that you add up the results and if you get a certain percentage, you have a hobby or a business. You have to look at it holistically and see if overall an outside observer would think that you are trying to make a profit.
This is why the question I use boils the IRS test down to the heart of things,
“What do you want? To make a profit or to occasionally cover the cost of your supplies?”
The reason I like this question is that the IRS test really boils down to intent. Your intent determines if you have a hobby or a business.
Your intent impacts your:
- recordkeeping requirements
- taxes (hobby expenses are no longer tax-deductible)
- expectations when it comes to the legal side of things
Your intent is all that matters in the eyes of the law and the IRS. If you intend to occasionally cover the cost of your supplies, you have a hobby. And hobbies don’t have legal or tax requirements.
If you intend to make a profit, then you are running a business in the eyes of the law and the IRS. And you are expected to treat it like a business. (And do all of those things that are expected of businesses.)
Of course, if you intend to make a profit, that doesn’t mean you need to go hog wild. You shouldn't get yourself in a bunch of debt or spend money willy-nilly.
But you do need to tackle those things that will help you prove to the IRS that you are running a business. And in turn, deduct your expenses (or your business loss) on your tax return.
These things include:
- creating a simple business plan
- picking the right business type
- getting the required permits and licenses
- picking a business name that won’t land you in legal hot water
Did you decide that your creative side project is a business? Pick up a copy of my book The Legal Roadmap for your Creative Business, and get a straightforward strategy to get your legal ducks in a row without all the confusing legal jargon for just $20.
Is selling paintings a hobby or a business?
Molly has been painting for about ten years and about a year ago she created an Etsy shop to sell her original paintings. She has only made two sales, but this year she set a goal to make about $2,000 to allow her children to participate in their favorite extracurricular activities.
So far, the only promotion Molly has done of her Etsy shop is the occasional Instagram post when she finishes a new painting.
Now Molly has the goal of covering the costs of her kids’ extracurricular activities, she knows that she needs to learn how to increase her shop sales. So she decides to set aside two hours a week and to track which of her actions leads to the most sales.
Verdict: Molly’s Etsy shop is likely a business.
Because Molly is putting in time and effort to make her Etsy shop profitable (and learning the skills required to make it profitable), she has a business. It doesn’t matter that she’s using the income for “extra” things for her family or that she’s only making a few thousand dollars. She’s trying to increase her shop sales and is tracking which actions increase sales, both of which point to the fact she’s trying to make her shop profitable.
When to register your hobby as a business?
When it comes to the “hobby or business test”, it’s not about how many of the nine items on the IRS test you answer yes or no to.
Instead, it’s about what is your intent.
- If you are taking actions that show you hope to make a profit, you probably have a business.
- If you aren’t taking actions that show you hope to make a profit, you probably have a hobby.
Your action item:
Answer the following question:
“What do you want? To make a profit or to occasionally cover the cost of your supplies?”
- If you want to cover the cost of your supplies, then in the eyes of the law, you have a hobby, not a business. And hobbies don’t have legal or tax requirements! Please close this window and go create. And come back if things change.
- If you want to make a profit, then you have a business in the eyes of the law and the IRS. This comes with certain benefits but also requirements and expectations.
Want my step-by-step guidance to knocking out the requirements and expectations of a business? That’s exactly what we cover in Map #2 of the Legal Roadmap. It guides you through getting enough legal stuff to keep your business out of legal hot water. You can pick up your copy of the book here.
About The Author
Kiffanie Stahle AKA Kiff is the friendly legal eagle behind the artist's J.D. A place designed to add ease to the legalese of running your creative business. She is a firm believer that you can protect your ass(ets) without legal confusion. When she's not geeking out on the law, you can find her and her pup Ozzy puttering around the western United States in their travel trailer. Continue the conversation with Kiff here.
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