Do You Have A Money-Making Hobby? | Preparing for Early Retirement
There’s no doubt that a moneymaking hobby can dramatically reduce the amount of time until retirement. If you have a profitable hobby, you may be able to enjoy retirement a lot sooner. Whether or not you choose the option of early retirement depends on your financial goals and risk tolerance. But many people find that having a profitable hobby can help reduce the amount they need to save each month in order to retire on time.
However, income from your hobby, like most other sources of income, is taxable.
Taxes are a significant expense that should be minimized when possible.
This is a touchy issue for the IRS. Many people try to deduct losses for activities that are primarily conducted for enjoyment. It’s easy to get yourself into trouble.
Hobby Tax Tips
1. For tax purposes, understand what “hobby” means. A hobby, according to the IRS, is an activity that is done primarily for enjoyment rather than making a profit. If your activity is considered to be a hobby, you can’t use the tax deductions available to legitimate business. However, you will be taxed for profit and can deduct your expenses in the same year.
For example, you couldn't deduct $1,000 in rare coins from your other income if you didn't earn any money. If you sold the coins for $1,200, however, you would be taxed on the $200 profit if you sold them in the same tax year you purchased them.
2. Hobbies are terrible for tax purposes. It’s important to create a business for your hobby. Think business, not hobby. If you expect to make a profit, and your expectation is considered to be reasonable, then you can consider your hobby to be a business. There is more information available from the IRS here. If you want to make money from your hobby, there's no reason not to declare it a business. Remove the word "hobby" from your vocabulary when dealing with the IRS.
3. Consider hiring your non-working family members. Remember that no income tax is due until you reach a particular earning level.
Paying a salary to your children or non-working spouse to assist you with your business is an excellent strategy to avoid paying income taxes. Paying your spouse allows you to keep the money in your joint account. daying your children provides a great way to save money for college, tax-free. Ideally, you would be in the position to pay both.
4. If your goal really is early retirement, consider investing the profits in tax-deferred retirement accounts. Your selections will differ depending on your financial level. An IRA, on the other hand, makes a lot of sense. You can, at least temporarily, avoid paying taxes on your earnings.
After-tax income is required for a Roth IRA, but the earnings are tax-free. Traditional IRAs are funded with pre-tax funds, but earnings are taxed.
IRAs are fantastic but keep in mind that the money is not yours until you reach the usual retirement age. If you intend to retire early and require the funds, make sure you invest them sensibly. Avoid splurging on unnecessary purchases.
Learn how to run a business wisely. There are a plethora of books and other sources that will provide the information needed to run a business effectively. Maximize your income for the amount of time you want to dedicate to your hobby. Don’t hesitate to get expert tax advice, too.
A moneymaking hobby can be an important part of any early retirement plan. Think about the things you like to do and make a list of ways you can make money from those activities. But take the steps to avoid paying more taxes than necessary.