From Hobby to Legit Business: How to Avoid Trouble with the IRS

It’s not uncommon to be juggling a full-time job while trying to start your own business on the side. In fact, many of us dream of turning that side hustle into something more—something that can replace the 9-to-5 grind. But here’s where things get tricky: how do you make sure the IRS views your business as an actual business, and not just a hobby?

The IRS has some pretty strict rules about this, and not following them can land you in a lot of trouble. With more people than ever turning to side gigs or small businesses, especially since COVID turned the world upside down, it’s become super important to understand what separates a business from a hobby in the eyes of the IRS.

So, let’s dive into what you need to know to make sure your side hustle is seen as a legitimate business, not just a hobby.

The Rise of the Side Hustle

The pandemic showed us all just how fragile job security can be. When everything shut down in early 2020, a lot of people realized that having only one source of income—like a full-time job—was risky. Many turned to side businesses or gigs to bring in extra money, and for some, that became their full-time income.

But the question I often hear is: “Will the IRS come after me if my side business is losing money? What rules should I be following?” It’s confusing, right? And you’ve probably heard that classifying your business as a hobby can get you in trouble with the IRS.

Let’s clear up the confusion and talk about how you can make sure the IRS sees your side gig as a legitimate business, not a hobby.

What’s the Difference Between a Hobby and a Business?

When it comes to taxes, the main difference between a hobby and a business is whether or not you can take a loss. If your business is legitimate and it’s losing money, you can deduct those losses on your taxes. But if the IRS decides your business is actually a hobby, you can’t use those losses to offset your other income.

So, how does the IRS decide? They use a 9-point test to determine whether you’re running a business or just having fun with a hobby.

The IRS 9-Point Test: Is Your Business Legit?

1. Profit Motive: Are you trying to make money? It might sound simple, but you need to show that your intention is to turn a profit.
2. Business-Like Operation: Are you running your side hustle like a business? Are you keeping accurate records, maintaining separate bank accounts, and making decisions to improve profitability?
3. Time and Effort: How much time are you putting into this business? If you’re only working on it a few weekends a year, it may look more like a hobby. But if you’re burning the midnight oil and working every chance you get, that’s a point in your favor.
4. Expertise: Do you have experience or knowledge in your field? Even if you’re learning as you go, working with advisors or getting trained shows that you’re serious about making it work.
5. Track Record: Have you made a profit in similar activities in the past? If you’ve had success before, it’s easier to argue that you’re aiming for profitability now.
6. Appreciation of Value: Are you building something that’s going to increase in value, like real estate? The IRS understands that some businesses take time to grow in value.
7. Financial Support: Are you relying on this business for income? If it’s just a side hustle and you’re financially stable with a full-time job, it may be harder to prove it’s a business.
8. History of Income and Losses: If you’re consistently losing money year after year, that’s a red flag for the IRS. Occasional losses are okay, but a long streak of losses can cause trouble.
9. Personal Enjoyment: It’s totally fine to love what you do, but if it looks like you’re having a bit too much fun and not treating it seriously, the IRS might see it as a hobby.

How to Strengthen Your Case: Proving You’re Running a Business

Now that you know the IRS criteria, let’s talk about how to make sure you’re on the right side of things. If your business is new and losing money (which is common), you need to build your case that you’re running a legitimate operation. Here are four key things you can do:

1. Keep Detailed Records: Document everything—your income, expenses, marketing efforts, changes in strategy. The more you document, the easier it is to prove you’re running a business.
2. Separate Finances: Open a separate bank account for your business. This shows the IRS that you’re taking your business seriously and helps keep your finances organized.
3. Create a Business Plan: Have a solid business plan that includes financial projections, marketing strategies, and profit goals. This proves you’re working towards making your business profitable.
4. Seek Professional Help: Hiring a tax advisor, accountant, or business coach shows you’re committed to running a legitimate business. People running hobbies don’t usually hire experts.

It’s Not Always Easy, But It’s Worth It

Running a business isn’t for the faint of heart, especially when you’re trying to do it on top of a full-time job. But if you’re serious about turning your side hustle into something bigger, it’s essential to treat it like a business from day one. And that means understanding the rules and building a solid foundation to avoid trouble with the IRS.

Whether you’re in the startup phase or already turning a profit, having a solid team and systems in place is key. If you feel unsure about your finances or need help navigating the complexities of taxes and business growth, don’t hesitate to reach out. I’m here to help you gain clarity and confidence in your business journey.

The line between a hobby and a business can be blurry, but by following the IRS rules and taking the right steps, you can confidently build something real. If you’re in it for the long haul, it’s time to treat your side hustle like the business it is and avoid the trap of being labeled a hobby.

Thanks for reading, and here’s to your business success!

To listen to my most recent podcast on?Spotify?– click?here!

To listen to my most recent podcast on?ApplePodCast– click?here!