How to Determine if Your Side Hustle is a Business

Side Hustle, Hobby or Business

How to Determine if Your Side Hustle is a Business

Is your side hustle a business?  Recently, I was posting in a Facebook Group.  The administrator of the group removed my post.  He explained that their group was for side hustles only, and my post was for a business.  Wait, what?!?!  I am an accountant.  I know that side hustles are typically businesses unless they are hobbies or jobs (I’ll explain in detail later).  So, his distinction (or, lack thereof) was confusing. 

A side hustle being a business, hobby, or job should be determined by the person in the side hustle, not a Facebook group administrator. 

It got me to thinking – how many people has he erroneously told that their side hustle is not a business?  There are probably a lot of people out there being misinformed.  Not just by him, but by other people like him.  They may mean well, but they are setting side hustlers up for trouble. 

As a result of this interaction, I thought it might be a good idea to set the record straight.  I may even be able to keep a few side hustlers from getting audited by the IRS.

Is Your Side Hustle a Business?

Side Hustles can be categorized in three different ways:

  1. An Employee

  2. A Hobby

  3. A Business

Employee

No matter how you make extra money, you need to report the income on your tax return.  How you report it depends upon how you are paid.  

The employee option is easy to determine…  

If you are working for someone else and taxes are being withheld from your pay, you will receive a W-2.  In this scenario, you are considered an employee of the company.  Therefore, when you file your tax return, you simply report the wages like you would with any other job.

Determining whether your side hustle is a business or a hobby is a bit more complicated.  Therefore, the IRS offers these helpful determining factors…

Here are nine things to consider when determining if an activity is a hobby, side hustle or a business:

Whether…

  • The activity is carried out in a businesslike manner and you maintain complete and accurate books and records. 
  • The time and effort you put into the activity shows you intend to make it profitable. 
  • You depend on income from the activity for your livelihood. 
  • Any losses are due to circumstances beyond your control or are normal for the startup phase for this type of business. 
  • The method of operation is changed to improve profitability. 
  • You (along with your advisors) have the knowledge needed to carry out the activity as a successful business. 
  • You were successful in making a profit in similar activities in the past. 
  • The activity makes a profit in some years (and how much profit it makes). 
  • You can expect to make a future profit from the appreciation of the assets used in the activity.

Hobbies

Essentially, for your side hustle to be considered a hobby, you are not in the side hustle to make a profit.  For example, if you create craft items for fun and sell them every so often.

Note:  If you have set up your side hustle as a business, and you incur a loss for several consecutive years, the IRS may inform you that your business is not a business, and should be reported as a hobby instead.  If you can show proof to the IRS that you are running the side hustle as a business, with the objective of making a profit, you should be able to continue the side hustle as a business.

To clarify, the two main differences between hobby income reporting and business income reporting are:

  1. Hobby losses (the expenses you incur for running your side hustle) cannot exceed your hobby income
  2. Hobby income is not subject to self-employment taxes

The fact that hobby income is not subject to self-employment income is a good thing, however, not being able to deduct expenses in excess of your income can certainly be a disadvantage.

Business

Lastly, if your side hustle does not fall into one of the previous two categories, then it should be considered a business.  

Best Practices for Side Hustles and Businesses

Create a business entity that makes the most sense for your business (LLC, S-Corporation, Partnership, etc.).  Download a list of Pro’s and Con’s for the most common business entities here.

Obtain an EIN (Employer Identification Number)

Register your business in your state of residence

Get a separate business checking account and credit card to use exclusively for the business. 

Note:  When first starting a business, you may not have the capital to use business income for your business purchases.  You can use your personal money, but be sure to track your business income and expenses separately from your personal income and expenses.

Track all of your business income and expenses.  In other words, documentation is imperative.  Consult with an accountant to determine which expenses are deductible and which are not (deductions are a topic for a different blog). 

For example, you can download a basic expense tracking spreadsheet here to get you started.

Tax Advantages and Disadvantages

Of course, there are advantages and disadvantages to running a business (as there is with anything else)…

One of the biggest advantages to running a business is that you are allowed to deduct expenses to offset income earned in your side hustle, even if those expenses exceed the amount of your income (unlike a hobby).  Having a business loss can lower your overall tax liability.

On the other hand, one of the biggest disadvantages to running a business is the additional tax you will pay on your side hustle income.  Depending upon the type of your business entity, this could include self-employment tax (business tax is a topic for another day). 

Bottom Line

In conclusion, if you are starting a side hustle, it is imperative to determine which category your side hustle falls under.  If you are starting a business, it is a good idea to reach out to a competent accountant to ensure that you get started on the right path from the start, because this could possibly help you avoid an IRS audit in the future.  

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