What’s the difference between a hobby and a business? For most of us, this line can get pretty blurred, especially when you’re striving to build a business out of your creative passion. But, in the eyes of the IRS, there’s a very clear distinction:
Businesses can offset losses against money they make elsewhere. Hobbies can’t.
This means, if the IRS decides your creative pursuits are a “hobby” rather than a business, you won’t be able to write off any expenses you incurred from it on your tax return.
You’re serious about starting a creative business. This is way more than a “hobby” to fill up your free time, but in order to retain the financial benefits, you need to prove this to the IRS. Here are a few steps you can take to do this:
Create a separate identity for your business
Drawing a clear distinction between you and your business helps demonstrate to the IRS that you’re taking this seriously. On top of that, it can also help you take yourself seriously: this business is the real deal, and you’re taking the steps to prove that like:
Get an EIN from the IRS: an Employee Identification Number is your means of identifying your business on tax forms and filings. You can apply for it for free from the IRS and receive it almost instantaneously, allowing you to create a separate identity for your business instead of using your name and SSN on official documents.
Separate your banking: create a bank account for all your business ingoings and outgoings that’s separate from your personal account.
Consider your structure: Creating a separate legal structure for your business isn’t a requirement to be legitimized by the IRS, but it certainly does help. Plus, certain business structures may help you save money on income tax. We go in depth into each business structure type and their potential tax benefits in our free Minding Your Business: Mini Course.
Keep diligent records
The very first point the IRS lists when distinguishing a hobby from a business is “whether . . . the taxpayer maintains complete and accurate books and records.”
As accountants, this subject naturally has a place close to our hearts. Meticulously kept accounts means you’re more likely to find a way to reduce your tax liabilities and keep more money in your own pocket on top of legitimizing you to the IRS.
So whether it’s a towering filing cabinet of paper receipts, snapping a quick picture to store in a mobile app, or a good old fashioned spreadsheet, a solid record of your business’ bills, contracts, and invoices is hugely important.
Show pursuit of profit
You’re doing this for more than an impressive income. Your purpose goes way beyond profit, and we get that. But, to the IRS, a business exists to make money. That’s it.
It may be a cynical worldview, but it’s one we have to resign ourselves to to a certain extent to keep the taxman happy. If your business is reporting losses year after year after year, the IRS will eventually start to question how serious it really is.
You need to be able to prove you’re conducting business and making operational decisions in the pursuit of profit. Even if you’re planning to donate every single cent your business makes, you have to have a mindset focused on generating some amount of bottom line cash.
Transforming your creative passion into a full-time career is not for the faint of heart. But you’re not settling for anything less. The best part is, you don’t have to do it alone.
Our Minding Your Business: Mini Course is an introductory breakdown of six foundational aspects of starting and scaling a creative business. From mindset to business structures, accounting to protecting your intellectual property, we’re answering all your burning questions.
And did we mention it’s totally free?