From woodworking to soap making, many activities can be sources of income, but is it earned income, or hobby income?
If you haven’t turned a profit in three or more years, the IRS might say your business is a hobby. Making money alone isn’t enough for the IRS to consider you a business. You need to proactively demonstrate that your business is valid
If your business is considered a hobby by the IRS, you cannot deduct business losses and expenses on your tax return. And, you can only deduct your hobby expenses up to the amount of your hobby profit. Treating hobby tax as income tax, you could end up getting IRS penalties and have to pay back the deducted amounts
The usual way to determine if you business is in fact considered a business and not a hobby by the IRS to to make some kind of profit 3 out of the first 5 years in operation. There are no definite concrete lines that determine a hobby from a business, but making a profit can prove it’s a business.
Not all businesses make a profit the first few years, most companies turn no profit the first 3 years, and simply stop operation. If it is your first or 2nd year in business, worries about profit are not a huge considering factor, but you are expected to make more profit than loss by year 3.
Be sure you’re familiar with the tax implications at IRS below: