Is It a Hobby or a Business? 5 Things You Need to Know to Monetize Your Hobby. Pay attention to this distinction because you can bet that the tax man is going to.
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We Americans are known for our creativity, ingenuity and entrepreneurial spirit. Those of us who actually are entrepreneurs are always thinking outside the box, pushing boundaries and looking for ways to solve a pain point for our customers.
Others rebel against the corporate environment, and some are pushed toward entrepreneurship by circumstances.
The economic downturn of 2008 was one of those big circumstances -- a big one. The recession pushed many professionals, young and old, to find alternative ways of employment when jobs were in high demand, but short supply.
Many became freelancers -- entrepreneurs in their own right, which in turn gave them the opportunity to pursue their passion outside the corporate bubble. What resulted was the rise of the "freelancer economy," which today accounts for 55 million freelancers -- up from 53 million in 2014, according to a Freelancers Union survey. Currently, freelancers make up 35 percent of U.S. workers and collectively earn $1 trillion.
The younger, 18-to-24-year-old, segment of those workers are more likely to freelance than are their baby boomer elders. And pursuing what was a hobby as a job is something both generations have long done and continue to do successfully. However, they should proceed with caution, because like any other business endeavor, there are legal issues to be aware of, one in particular being the "tax man."
In fact, your tax liability will be affected depending on whether your work is classified as a hobby or (as the IRS classifies it) an actual business.
So, how do you know if it's a hobby or a business? That's something you need to answer objectively, to avoid headaches down the road. Here are some checks and balances to help you determine that:
- If it's a hobby, all income is reported, but deductions are limited to the income taken in. Deductions may be claimed only as miscellaneous itemized deductions, and only the amount in excess of 2 percent of your adjusted gross income (AGI) may be claimed.
- If it's a business, all income is reported, but a number of expenses may be offset. If you are profitable, you are able to shelter income and put some money aside for an emergency fund, retirement, etc.
As we near tax season, it's important to know that any income from any activity is reportable and taxable. And, even if it's a hobby, you need to run your business like a business and pay close attention to your profits and losses.
According to Liberty Tax Service's Brian Ashcraft, "If you take a loss on a business for more than three years, the IRS considers it a hobby, and it is not eligible for preferential tax treatment. The IRS assumes that if an activity isn't profitable for at least three of the prior five tax years, including the current year, then losses from that so-called business cannot be used to offset other income."
Knowing which tax pitfalls to avoid is key for any business. So, whether you're a millennial looking to start a business or a retiree trying to boost your income, here are five ways to help you monetize your hobby.
1. Pick the right hobby.
If you're serious about monetizing your hobby, make sure you've picked the right one. Personally, my hobbies involve eating bacon, hunting pheasant and clearing brush -- fun for me, but not very profitable endeavors. I tried my hand at a pheasant farming business, and it failed spectacularly. Not because there wasn't a market for it -- I'm from South Dakota, so yes, there is a market -- but because the birds drowned in a rainstorm.
If, unlike me, you have more mainstream hobbies like photography, music, writing or crafts that are easier to monetize, you might be onto something. If you're a photography buff, for example, you could sell your pictures on a number of websites, like Shutterstock, or join a community like Kodak Winning Fotos. That company's CEO, David Young, told me, "Turning a hobby into a business requires critical insight into your passion. I think we're naturally reluctant to question passion, usually for fear of diminishing or tainting the high we feel without thinking.
"Don't be afraid to explore the root drivers of your enjoyment. It's essential for transforming a hobby into a successful business."
Meanwhile, if you're a crafty entrepreneur, you could sell your wares at sites like Etsy or Café Press. If you're a musician, you could start a business teaching neighborhood kids to play the guitar or the piano, or launch an afterschool program teaching music to underprivileged kids.
2. Start small.
It's great to dream big and have lofty goals, but idealism without a dose of realism doesn't work all that well. Apple started in a garage, so don't think you need a fancy operation in order to be profitable. Also, remember that if this is your hobby, you don't have to immediately turn it into a full-time job.
Dream big, but start small. Freelance a few hours a week; see how the demands of your hobby align with the realities of the industry. If your hobby, and all its demands, is still enjoyable after you've done it for a while, that's a clear signal to start growing your hobby into a business.
3. Make marketing a priority.
People think about marketing as something for "down the road" or "when we're more established," but you need to start your marketing on day one. Heck, I would say have a marketing plan before you start. A marketing plan should be part of your overall strategy. If you have a sound marketing strategy prior to launching, a plan further helps build a little suspense and anticipation.
Getting the word out about your new business is key, if you intend to make any money. You need to leverage every contact -- every client, acquaintance, friend, family member, co-worker, teacher, mentor, etc. Some might even hire you and help you spread the word. This could turn into referrals, and next thing you know, you might have people looking to hire you.
Word of mouth is probably the oldest way to advertise, and still one of the most effective.
4. Treat it like a business.
Just because it's a hobby doesn't mean you don't treat your work like a business. It's okay to have fun and love what you're doing, but if you're not going to be serious about it, you may as well quit pretending. I love what I do so much that I would do it for free if I could; however, I also take seriously my conditions of satisfaction, one of them being, "Make money."
One way to keep yourself in check is to establish the number of hours you're dedicating to turning your hobby into a business. Stick to that schedule, at least at the beginning. If you start slacking and cutting corners, that's a bad way to start. If you're going to break the rules, you have to know what the rules are, first.
5. Branch out.
If you have a hobby that you could branch out on, consider that option. For example, a photographer can always do more than take photos and sell them. A photographer can establish himself or herself as a thought leader by promoting personal skills and knowledge or giving lessons. If you're an artist, there's more for you out there than selling your paintings or playing your music. So, teach others; mentor; teach the business behind your hobby.
I am a marketer by trade, but I have also been in business for a long time and have learned many lessons that I like to impart to others. As a National Speakers Association Hall of Fame member, I do a number of keynote speeches around the country, teaching others the business side of things. I practice what I preach. I live by the adage, "Adapt, change or die."
There's more than one way to do things and the more avenues you can pursue to monetize your hobby, the more successful you'll be.
What hobby would you turn into a business?