Hobby or Business? How the IRS Sees Your Garage Side Project
Many people start a garage business as a side project and wonder when it stops being “just a hobby” in the eyes of the IRS. The answer matters because it changes how you report income and whether you can deduct losses. This is general information, not tax advice.
Why the Label Matters
The IRS says that if you do not intend to make a profit, you generally cannot use losses from the activity to offset your other income. Income from an activity not engaged in for profit is still reportable, and the IRS directs taxpayers to report it on Schedule 1 (Form 1040). A real business, by contrast, reports income and expenses on Schedule C, and a net loss can usually be deducted, subject to some limits.
What the IRS Looks At
There is no single test. The IRS lists several questions it considers, including:
- Do you run the activity in a business-like way, with accurate books and records?
- Do you change your methods to improve profitability, such as advertising or finding better suppliers?
- Have you studied the business side of the activity or asked experts?
- Do you spend significant time and effort on it?
- Do you expect to make a profit, or have you turned similar ventures profitable before?
- Are losses normal for a startup, or do they continue long past the time needed to become profitable?
- Do you have personal or recreational motives?
A new business is allowed to lose money at first. What matters is whether you are really trying to make it profitable.
Habits That Support a Business
- Open a separate bank account and keep personal spending out of it.
- Track every sale and expense; our bookkeeping basics post shows a simple system.
- Write a one-page plan with price points, costs and goals.
- Market your products or services regularly.
- Review your numbers monthly and adjust.
If You Have Business Income
The IRS says sole proprietors with net self-employment earnings of $400 or more must file Schedule SE to calculate Social Security and Medicare tax. Self-employed people generally also pay estimated taxes during the year. Our garage business taxes guide covers these topics in more detail.
Talk to a Professional
Tax rules change and individual situations differ, so a CPA or enrolled agent can help you decide how your activity should be treated. Free help is also available; see our post on SCORE and SBDC mentors.
More on Garage Business Blueprint
- Taxes for a Garage Business: Self-Employment Tax, Quarterly Payments and the Home Office Deduction
- Bookkeeping Basics for a Garage Business: A Simple System That Works
- How to Choose the Right Garage Business Idea
