As a creative, it may make sense to share your work with the world on an online marketplace like Etsy or eBay. But when there’s money involved, you can bet there are tax implications to consider — and the IRS wants to know whether you’re selling your wares online as a business endeavor or a hobby.
Business or Hobby?
You may not have defined for yourself whether selling online is a hobby, a side hustle, a business or somewhere in between. But the IRS needs to know your classification for tax purposes.
The biggest differentiation between being a business or a hobby in the eyes of the IRS is your intention to earn a profit. In other words, is it primarily a money-making activity, generating income that you rely on? Or is this something you do on the side just for fun, earning some money here and there?
Why It Matters
If you’re selling online part-time, you might think the business or hobby designation is pure wordplay. But to the IRS, there are meaningful tax implications you need to be aware of.
For example, if you have a business, you can deduct many expenses that are considered crucial to the function of your business, including marketing, advertising, shipping and work-related use of your home and car — which can lower your tax liability. If your expenses end up surpassing your income, you will have a Net Operating Loss (NOL), which may help lower your taxes in the future. While you may have to do some more work to classify your online sales as a business, you will ultimately reap more benefits.
Certain expenses related to a hobby can be written off only up to the amount of your hobby income, with allowable deductions including “ordinary and necessary” expenses (itemized on Schedule A). An ordinary expense is “common and accepted for the activity,” while a necessary expense is “appropriate for the activity.” But if your expenses are higher than your hobby income? Then you will have a loss, which you will not be able to write off.
Remember: Whether your sales are classified as a hobby or a business, you must report all income to the IRS.
How to Be Considered a Legitimate Business
If you want to avoid being considered a hobbyist and instead be taken seriously as a business by the IRS, there are a few things you can do:
1. Keep detailed records. For the IRS to consider your online shop a business, you need to treat it like one. That means you must keep detailed records of your income and expenses, and track your growth.
2. Make it profitable. A business is all about turning a profit, and the IRS wants to know that you’re dedicating your time and energy into making this a lucrative endeavor. If your sales are stagnant, consider using different platforms or marketing methods to gain more traction.
3. Rely on the income. If the sales from your online store make up a vital portion of your income, the IRS will consider it a business.
4. Operate like a business. Having a hobby can sometimes mean winging it. But the IRS wants to know that you have the necessary knowledge to continue running your business in order for it to be classified as one. Do your research on your market, and have a growth plan and operating systems in place to take you to the next level.
5. Have a plan for increased revenue. If you have a plan to build your revenue and grow your online store — and you expect to make a profit in the future — you can consider the activity a business.
The Bottom Line
Whether you classify your online store as a business or a hobby, it’s important to put aside some of that income for your taxes each year, and to understand how it will affect your overall tax situation. There’s a difference between being considered a hobby or a business, so no matter which option you choose, it’s essential to be aware of the overall impact on you and your finances.