Almost everybody has a hobby. While someone may love baking and trying new recipes for fun, another may be obtaining baking orders from neighbours, colleagues, and/or friends to generate additional income. What could be better than doing what you love, and earning from it as well? Although enticing, when this income becomes regular, or is of a significant amount, it attracts taxes. In Canada, this is the ‘hobby tax’, which is levied on the net income earned from a hobby.
Recently, many Canadians have turned into entrepreneurs by making either their hobby an income source, or by selling objects online through third party websites. Leveraging social networking sites have made it easier to attract clients and sell a product or service. Unfortunately, all that hard work, regular income and sometimes a huge tax amount, does not make your hobby a business. If the CRA deems that your hobby is not a business, any losses incurred do not qualify for deduction from other sources of income.
However, there are a few precautions and protocols that can help you prove that your hobby is a business and therefore tax deductible. This can be a great way of saving on your taxes while doing what you love. AG Tax analysts have prepared an article on how hobby expenses can qualify as a tax deduction, and what other things to keep in mind.
The Difference Between ‘Business’ And ‘Hobby’
As per the CRA, a business is something that an individual pursues with an agenda to make profit. It should include elements and steps involved in a business, and even if no profit is made initially, the commercial activity carried out by the individual should prove as a direct competition to others who are pursuing the particular work as a business, and are fully profit motivated.
Meanwhile, a hobby is generally pursued with no intention to make profits, and therefore any income made from it is not considered as ‘business income’, but ’hobby income’.
Is Hobby Income Subject To Income & Sales Tax?
This ‘hobby income’ (profit from hobby, income less expenses) is subject to hobby taxes, and needs to be reported as ‘business income’ on Form T2125, Statement of Business or Professional Activities. The hobby will not be considered as a trade or business by the government since the hobby isn’t being pursued with an intention to make profit or earn income.
As for sales tax, businesses are required to pay sales tax if they have annual sales equal to, or more than CA$30,000 related to a non sales tax exempt endeavor. The same rule applies for hobby income. If the net income exceeds $30,000 (a rare situation), only then will the hobby income be subject to GST/HST, otherwise not.
The trouble starts when a taxpayer is making regular income from a hobby. The taxpayer then pays taxes in years which there is profit (income less expenses) from the hobby as ‘hobby tax’ but is unable to claim any hobby expenses incurred as losses for those years in which there is no profit. This seems unfair, since a business pays tax on any profits made, just like a hobby, but qualifies to claim or carry forward the losses on their tax return.
Is it simply because the business owner has an intention to realize a profit?
When Does Hobby Qualify As Business?
The CRA does consider ‘profit intention’ as one of its criteria for determining whether an activity is a business. Fortunately, this is not the only point taken into consideration.
For any hobby to qualify as a business, the activities of the undertaking have to be carried out in a ‘business-like’ manner. This is the case even if you aren’t actually making any money.
Some of these ‘business-like’ factors are as follows:
- The activity should be seriously and earnestly pursued;
- The activity should be pursued with full dedication with reasonable and recognizable continuity;
- The activity should follow general business principles, such as: maintaining records, or professionally dealing with buyers/purchasers, for example: taking bills from suppliers and providing receipts to buyers, the supplier should be supplying at regular market rates (no huge differences) with intention to profit, employees (often family members) should be paid as per market standards for the work completed; and
- The activity supports other activities which are directed towards earning revenue.
It is not necessary that all these conditions be fulfilled. Likewise, there may be other factors such as: whether there is an office, business logo, advertising, or genuine customers (not just friends and family). These could be taken into consideration depending upon the nature of the activity or hobby. A good way would be to match the hobby activities to the activities of someone carrying out that as a profession, such as: following the same business protocols for a baking hobby business as a professional baker would.
That being said, it is tough to foresee whether a hobby would be profitable or not. A taxpayer should consider maintaining a separate record of the income generated and expenses incurred on the hobby regardless of whether they have actually made any profits yet. Initially, one may not be able to claim the losses, but if in the long run the hobby becomes a regular and continuous activity, and the income and losses are on a frequent basis, it would be easier to claim the hobby as a business if there are historical records.
However, if the hobby rarely makes a profit, or the income and expense figures are very disproportionate, it could trigger a red flag, and the CRA may issue an audit notice to verify if the business is truly a business.
With a bit of planning your hobby could quite quickly become a great way to make some extra money and get a tax deduction while doing something that you love.
AG Tax LLP Can Help
If you wish to discuss further on the above issue, or have any tax-related queries or need assistance with tax planning or filing please contact AG Tax. Our tax professionals are highly-experienced with U.S. and Canadian tax laws and can provide you the right guidance to handle your tax situation.
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