Are you considering turning your fun hobby into a small side business? It's a fantastic way to make a little extra income doing something you love. But, in order to use your expenses and even use a business loss to reduce your overall income, you'll need to understand how to prove to the IRS that your business is an actual business. Here are 5 ways to do just that.
Make Profit. Obviously, the primary way most businesses show that they are legitimate business ventures (as opposed to a hobbyist trying to use personal expenses to lower taxes) is to earn a profit. However, this may be harder than you think and many businesses fail to turn a profit in the first year or two. This is acceptable by the IRS, which generally still considers you a legitimate business if you only make a profit in 3 out of 5 years.
Use Quickbooks. Using a popular small business software tool like Quickbooks gives your enterprise legitimacy. It allows you to record invoicing, vendor payments, travel expenses, licensing, and advertising. It also allows you to easily create monthly, quarterly, and annual reports to help your accountant prepare your income taxes with plenty of backup documentation. Setting up your business in Quickbooks can be somewhat complex, so you likely want to get help from a professional accountant to get things started and perhaps to provide monthly maintenance.
Advertise. Advertising shows that you're trying to attract new clients and grow your business. You don't have to spend a lot of money to prove that you're advertising. You may be able to advertise for free in local online groups or through social media. You could put up flyers in your area or rent a booth at a local trade show or hobbyist gathering. Be sure to record your advertising efforts if they are free, so you can refer to them in the future if you need to.
Write a Business Plan. A business plan is a written document outlining your different goals (both long-term and short-term) for the business and how you plan to accomplish them. You can learn how to write a basic business plan through the Small Business Administration's free online tools or in person.
Open an Account. Opening a separate business bank account keeps your side business expenses and income separate from your personal costs. This separation demonstrates that you are trying to keep track of your business properly and look at it from an objective viewpoint. While it may cost a little bit each month to maintain a business account, it's a step that most hobbyists wouldn't take.
Any of these methods -- or, better yet, several of them -- is a great way to demonstrate to the IRS that you are genuinely running a small business and not just a hobby. If you're not sure how to carry out any of them, you may want to consult with an accountant to get started. And, while it may take some time and effort, the result may be a tax savings and a positive new income for the future.