What is the difference between a hobby and a business? Sometimes it can be hard to tell –after all, some of the most successful businesses are those that start as hobbies. The problem is, from a tax perspective, hobbies and businesses are very different. That’s why, if you’re considering making the transition from practicing a hobby to running a business, it’s important to understand the financial distinctions. And of course, you need to determine whether your hobby is ready to make the leap from a personal passion to the professional undertaking.
Finding Inspiration
Many people with potentially profitable hobbies never choose to turn them into businesses because they like having something that’s just for them. Those who do take this next step, though, typically come from a few key sectors, such as photography and animal care.
Photographers can turn their hobby into a business by selling artistic images, taking portraits and headshots, and even working as a wedding photographer. Those with a passion for animals might work as groomers, dog walkers, or pet sitters, or even making treats and accessories.
Other people who transform their hobbies into businesses do so not by directly selling their work, but by using their knowledge to sell supplies or work as a middleman. Hunters, for example, might use their skill and understanding of hunting to sell hunting gear or lease out land for hunting. And then there are hobbyists who teach their skill to others, whether that means teaching macramé workshops or giving cooking lessons.
Assess Competing Companies
Once you’ve determined whether your hobby is profitable, the next factor you should consider is how your service might fit into the larger marketplace – and that starts with assessing the competition. That means seeing who else is in your niche, what they offer, and whether your sales proposition is sufficiently distinctive.
How far you need to look when assessing the competition depends on the type of business you intend to offer. If you plan to sell crafts online, you’ll be facing a much larger pool of competitors, while local businesses only need to assess the value of their product or service in the community. This is what Craig Jenkins-Sutton found when he first launched his business, Topiarius, as an extension of his love of gardening. Jenkins-Sutton’s outreach was intensely local – his most effective campaign involved distributing door hangers. Expanding such a business would demand a great deal of travel, which isn’t especially practical, but even working locally, Topiarius earned $1.2 million in 2011.
The Issue Of Incorporation
If you decide that your hobby is business ready, then it’s time to think about incorporating – and most people who make the move from a hobby to business opt to form an LLC. LLCs, short for limited liability companies, are the ideal format for a small business because they are inexpensive to form and they provide significant financial protection by separating your personal and professional assets. In other words, if your business doesn’t succeed, your personal assets can’t be seized. That’s important, especially during those first few precarious years.
The Accidental Business
Of course, not every person with a hobby turned business planned to take that track; sometimes the money just slowly starts rolling in, and suddenly your hobby is profitable. If you realize what’s happening, then it’s time to establish your legal status as a business. As above, it will likely make the most sense to incorporate as an LLC. From there, you can begin keeping proper accounts, determining your profit, and identifying what expenses you can deduct for tax purposes. Generally, you must consider what you do business if you make a profit for three out of five years.
Deduction Decisions
One reason that some people consider turning their hobby into a business is that, as a business, you are able to deduct things like craft materials and office supplies from your taxes. You have to be careful with this, though, because the IRS can be very suspicious of deductions along these lines and new tax laws are even more restrictive in relation to hobbies. That means there isn’t any room to experiment with the cost of running a business; either you can incorporate as a for-profit operation and deduct these expenses, or you can take on those costs and continue with your hobby.
Make sure you keep careful records and separate personal projects from your business undertakings. Typically, when a hobby becomes a business, you’ll still be engaging with it on a personal level as well. That yarn you used to knit your niece a sweater shouldn’t be counted as a deduction for your handicrafts business.
Time It Right
Finally, if you’re deciding whether or not to transform your hobby into a business, it’s important to consider whether or not this is the right time in your life to do so. For example, if you have several small children in the house, you may not have the energy to take on a new professional project, but if the kids are finally all in school full-time, that might be a good time to give such a project a go.
One period of life when many people consider transforming their small hobby into a small business is during retirement. Retired individuals have more time to devote to such projects, but they’re also living on a fixed income and developing your hobby into a business can provide some much-needed cash flow during those years. Do be careful, though, that you don’t overinvest in business during this time, as you don’t want to worsen your financial circumstances at a time when you don’t have significant income.
Turning a hobby into a business can be a fulfilling experience, but it isn’t easy. Just because you have the skills, doesn’t mean you’ll make a profit, or that you’ll fit into the marketplace. With that in mind, don’t be afraid to test the waters. Many businesses struggle during the first few years, so you won’t be alone if you’re operating in the red. And, most importantly, even if the business is tough, you’ll be doing something you love. Embrace this new professional adventure, but don’t let it take away from your favored activities.
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