In tax terminology, a hobby is an activity that is NOT engaged in for profit.
This is important because deductions for hobbies are limited, whereas deductions are (generally) unlimited for business activities engaged in with a for-profit motive.
Here’s an example of the difference.
Joe operates a business. He takes in $10,000 and spends $15,000 in business expenses. On his tax return, Joe can deduct a $5,000 loss.
Now let’s say Joe has not been operating his business with a profit motive. This is where the hobby rules kick in.
Joe must claim the $10,000 as income on his tax return. The $15,000 of expenses can be claimed with the following limitations: 1) the deduction is limited to the amount of income from the hobby ($10,000 in this case); 2) the deduction can only be taken as a miscellaneous itemized deduction; 3) only the portion that exceeds 2% of Joe’s adjusted gross income can be taken as a deduction; and 4) if Joe is subject to alternative minimum tax, the deduction is not allowed for AMT.
What If Your Hobby Generates a Profit Instead of a Loss?
Do the hobby rules apply if your income from the hobby is greater than your expenses? I’ve seen accountants argue about this on message boards. I believe the answer is yes, these rules apply even if you end up with a profit from the activity instead of a loss.