When is a Hobby Considered a Business?

While side hustles seem more common than ever these days, the reality is still a little surprising. A 2022 LendingTree study of 2,000 U.S. consumers found that 44% had a side hustle — and that’s up 13% from 2020.

With so many folks hustling on the side, it’s crucial to understand the ins and outs of converting a beloved hobby into a business. Because doing what you enjoy is pretty simple — it’s the additional income, stress, tax deductions, and paperwork that comes with classifying your hobby as a business that’s more complicated.

Is it a Hobby or a “Hobby”?

The IRS uses a set of guidelines to determine if an activity is a hobby or a business. However, in order to qualify as a business, your hobby doesn’t necessarily need to meet all these guidelines. What’s even more confusing is that, even if it seems like your hobby activities meet the guidelines to qualify as a business, it could still be categorized as a hobby.

To determine if your hobby meets IRS guidelines, you’ll want to start by asking yourself a few key questions:

• Has your hobby generated a net profit for three out of five years of operation?

• Do you have accurate bookkeeping practices and records?

• Do you depend on that income for your livelihood?

• Are you only pursuing your hobby for personal reasons (for example, you do it because you find it relaxing)?

Essentially, if you’re investing time and resources into generating a profit from your hobby, it’s likely considered a business under the IRS. But if it’s merely a leisure activity, it’s most likely a hobby. An accountant is best positioned to help determine the tricky legal landscape of whether or not your hobby is a business. Notably, even income earned from a “hobby” must be reported to the IRS. But if your hobby is determined to be a business, there are a few steps you need to take.

Transitioning a Hobby to a Business

Ask any entrepreneur and they’ll tell you that step one of starting a business is choosing the right structure for your business. Why? Because your business structure determines your business’s tax requirements, your personal liability, and the options available to you for financing your business.

Before you decide on a business structure, though, ask yourself the following questions:

• Do you want to keep your prior hobby-turned-new business the same? In other words, do you intend to change the way you operate or conduct your hobby now that you know it qualifies as a business?

• If you’re planning to expand your business, do you want it to remain a side hustle?

• If not, are you hoping to quit your full-time job and run this business in the future?

Business Structure 101

If your hobby is determined to be a business, one of the easiest business structures to choose is a sole proprietorship. Not only is this the most common type of business structure, but it’s also the easiest to form. As a sole proprietor, you would be the sole owner of your business and would also be responsible for the taxes, liability, and financing.

If you’re thinking about growing your new business, though, there are a few other business structures you’ll want to consider.

• A limited liability company, or LLC, is attractive to business owners for three key reasons. First, access to pass-through taxation which allows owners to enjoy the legal independence of owning a company without being subject to double taxation. As a result, LLCs are typically more financially sustainable for new business owners. Second, unlike with sole proprietorship, the owner is not personally liable for their business. Third, there's overall much less paperwork and administrative upkeep than corporations. An important downside to keep in mind with LLCs, however, is that LLC laws vary significantly state-by-state. Check here to learn more about the process of launching an LLC in your state.

• A C corporation is generally the preferred business structure of venture capitalists and angel investors, as the legal entity of the business exists separately from the shareholders. As with an LLC, the owner is not held personally liable for the business. However, unlike an LLC, C corporations are expensive and come with a significant amount of paperwork. Additionally, expect to be double taxed — once at the corporate level and again as an individual taxpayer.

• Finally, an S corporation is a convenient way to own a corporation while not being personally held for any liabilities and bypassing those sneaky double taxes. That being said, unlike an LLC, this type of business structure also comes with hefty costs and paperwork.

While there’s not necessarily a right or wrong answer when it comes to which business structure you choose, it’s important to think carefully about the type of taxes, liability, and funding you may need down the road before you decide.

Paperwork — Can’t Live With It, Can’t Live Without It!

After you’ve chosen your business structure, it’s time to acquire a business license and possibly even a business bank account. Now, if your plan is to operate your business much like your hobby, there isn’t a lot more that’s required to run your business. But if you’re hoping to grow and expand this side hustle, here are a few key steps to get you started:

• Create an Employer Identification Number online — you’ll need this to open a business bank account if your business structure is not a sole proprietorship

• Obtain formation documents for your business in the state it will be operating from

• Find out about any state licenses you need in order to operate

• Look to the National Federation of Independent Businesses to determine if you need business insurance and, if so, which provider and types of insurance are best for your company

• Consider getting a minority, women, or Black entrepreneur (MWBE) certification if you qualify

Finally, when all of your “i’s” have been dotted and your “t’s” have been crossed, it’s time to begin the hard work of growing your business through marketing, financing, and hiring. It can be overwhelming to go from doing something you love (your hobby!) to making money from that same passion. It’s not a path for everyone. But if you’re ready to go down that path, you’re not alone — so many others are in your shoes.

How Justworks Can Help

Perhaps your business is still just a hobby. But when you're ready, Justworks has your back with the tools and support to help your business thrive.

By starting a business has long been a dream of yours, or if your hobby has suddenly become a business, the journey ahead is both daunting and exciting. Justworks is here to help.

As your company grows, you don’t need to tackle everything by yourself. Justworks can help your business handle tasks like payroll, accessing health insurance, onboarding remote employees, and more so you can focus on growing your business.